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LOANS  AND  INVESTMENTS 

U 

CONTRIBUTORS 


O.  M.  W.  SPRAGUE 

Professor  of  Banking  and  Finance  in  Harvard   University 

E.   W.   KEMMERER 

Professor  of  Banking  and  Economics  in  Princeton  University 

H.  PARKER  WILLIS 

Secretary  Federal  Reserve  Board 

THOMAS  B.   PATON 

General  Counsel  American  Bankers  Association 

HAROLD  J.  DREHER 

Assistant  Cashier  National  City  Bank  of  New  York 

C.  W.  ALLENDOERFER 

Assistant  Cashier  First  National  Bank  of  Kansas  City 

GEORGE  E.  ALLEN 

Educational  Director  American  Institute  of  Banking  Section 
American  Bankers  Association 


Messrs.  Sprague,  Kemmerer,  Dreher,  Allendoerfer  and 
Allen  are  members  of  the  Institute  Board  of  Regent* 


American  Institute  of  Banking 

Section  American  Bankers  Association 
Five  Nassau  Street  New  York  City 


Copyright  1916 

By 
American  Institute  of  Banking 


CONTENTS 

Chapter  Page 

I.  Commercial  Loans 5 

II.  Agricultural  Loans 51 

III.  Stocks  and  Bonds 97 

IV.  Collateral  Loans 137 

V.  Seasonal  Demands  for  Money 177 

VI.  International  Exchange  216 

VII.  Bonds  and  Circulating  Notes 255 


LOANS  AND  INVESTMENTS 


CHAPTER  I 
Commercial  Loans 

BANKS  are  commonly  thought  of  as  being 
chiefly  eng^ed  in  the  business  of  lending 
money,  butl^)a  matter  of  fact  money  loans 
make  up  a  small  part  of  their  business.  The  invest- 
ments of  savings  banks  are  indeed  limited  to  the 
funds  which  they  have  received  from  depositors, 
together  with  such  amounts  as  have  been  set  aside 
from  profits  as  surplus,  and  also  in  the  case  of 
stock  savings  banks  the  amount  received  from 
subscriptions  to  capitaLstock.  Other  banks,  includ- 
ing the  banking  departments  of  trust  companies, 
while  they  must  always  be  prepared  to  furnish 
money  on  demand,  do  not  limit  their  loans  and 
other  investments  to  the  funds  received  from  de- 
positors and  shareholders.  They  lend  their  credit 
as  well,  and  thus  create  a  large  part  of  the  funds 
utilized  by  borrowers.  Banks  other  than  savings 
banks  might  well  therefore  be  called  credit  banks. 
Unfortunately  a  somewhat  less  descriptive  term  is 
in  common  use — Commercial  Banks. 

2.  BANK  NOTES  AND  CHECKS.  — Com- 
mercial banks  are  able  to  lend  their  own  credit  and 
thus  manufacture  a  large  part  of  the  funds  which 

5 


6  LOANS   AND    INVESTMENTS 

they  furnish  borrowers,  because  they  provide  a 
more  or  less  generally  acceptable  substitute  for 
coined  money  as  a  circulating  or  purchasing 
medium.  The  bank  note,  the  promise  of  a  bank 
to  pay  money  on  demand,  is  quite  obviously  a 
credit  instrument  which  is  a  substitute  for  money; 
and  in  the  absence  of  legal  restrictions  upon  issue 
the  volume  of  such  notes  in  circulation  would 
clearly  depend  upon  the  willingness  of  people  to 
accept  them  in  payment  for  goods  and  services. 
Partly  because  of  legislation  limiting  the  power  to 
issue  notes,  and  even  more  because  the  check  has 
been  found  more  convenient  for  most  purposes, 
the  bank  note  has  become  a  subordinate  and 
rather  special  means  of  extending  credit.  Banks, 
of  course,  do  not  extend  credit  directly  by  issuing 
checks,  since  the  check  is  an  order  on  a  bank  to 
pay  money,  not  a  bank's  promise  to  pay  money. 
Such  orders  are  based  upon  obligations  to  pay 
money  recorded  on  the  books  of  the  bank,  known 
as  deposits.  This  term  deposits  is  a  misnomer. 
It  suggests  to  most  people  that  the  bank  has  at 
some  time  or  other  received  from  depositors  the 
amount  of  their  deposits  in  money.  Banks  are 
often  spoken  of  as  lending  their  deposits.  This 
is  a  most  inaccurate  and  misleading  use  of  lan- 
guage, since  deposits  are  obligations  already  in- 
curred, an  existing  liability,  which,  moreover,  is 
largely  due  to  loans  granted.  Clearly  a  bank  can- 
not lend  its  already  existing  obligations  to  pay 


LOANS   AND    INVESTMENTS  7 

money  on  demand.  It  may  indeed  happen  that  a 
bank  receives,  let  us  say,  $1,000  in  money  from  a 
depositor,  and  is  on  that  account  in  position  to 
lend  more  than  might  otherwise  have  been  advis- 
able. But  even  here  it  is  not  the  deposit  which 
it  lends,  but  either  the  $1,000,  or,  and  this  is  far 
more  likely,  a  new  right  to  draw  $1,000.  Both 
transactions,  the  receipt  of  the  $1,000  and  the  loan 
of  $1,000,  will  then  have  created  absolutely  similar 
deposit  obligations. 

3.  LOANS  AND  DEPOSITS.— It  is  the  gen- 
eral use  of  the  check  that  makes  it  possible  for 
banks  to  create  deposits  through  their  lending 
operations.  If  borrowers  made  all  payments  with 
money  it  would  be  necessary  for  them  to  withdraw 
the  proceeds  of  their  loans  from  the  banks  in  the 
form  of  money.  The  business  of  commercial  banks, 
like  that  of  savings  banks,  would  then  be  limited 
to  the  funds  secured  from  depositors  and  share- 
holders, and  possibly  some  slight  amounts  in 
addition  thereto,  since  borrowers  would  presum- 
ably not  immediately  draw  out  the  entire  proceeds 
of  their  loans.  It  may,  however,  be  objected  that 
even  though  the  borrower  does  use  checks  the  bank 
will  be  obliged  to  make  payment  almost  as  speedily 
as  if  money  was  used.  Checks  do  not  circulate 
indefinitely;  they  are  quickly  presented  for  pay- 
ment over  the  counter  or  by  other  banks  in  which 
they  have  been  deposited.  Assuming  that  a  bank 
were  abruptly  to  double  its  deposit  obligations  by 


8  LOANS   AND   INVESTMENTS 

granting  many  new  loans,  it  would  be  confronted 
almost  at  once  with  heavy  demands  for  payment 
on  account  of  the  largely  increased  number  of 
checks  that  would  certainly  be  drawn  upon  it. 
Objections  of  this  sort  are  frequently  raised  against 
the  possibility  of  the  creation  of  deposits  by  banks 
in  excess  of  the  momentarily  unused  proceeds  of 
their  loans.  If  it  is  a  question  of  the  possibility 
of  extending  credit  by  a  single  bank,  such  objec- 
tions are  valid.  A  bank  which  should  suddenly 
increase  its  deposit  obligations  would  begin  to  lose 
cash  almost  at  once  because  more  checks  would  be 
drawn,  and  most  of  them  would  be  deposited  in 
ether  banks,  thus  occasioning  a  succession  of  un- 
favorable balances  against  it.  If,  however,  all  the 
banks  of  a  locality  increase  their  loans,  with  a  con- 
sequent expansion  of  deposits,  to  something  like 
the  same  extent  relative  to  the  scale  of  their  past 
obligations,  each  bank  will  have  a  greater  number 
of  checks  drawn  upon  it,  but  will  also  receive  from 
its  depositors  a  greater  number  of  checks  drawn 
on  the  other  banks.  There  will  be  a  greater  num- 
ber of  checks  drawn  but  not  a  correspondingly 
greater  amount  of  cash  needed  in  making  settle- 
ments between  the  banks.  This  increase  of  accom- 
modation to  borrowers  by  the  banks  of  a  single 
locality  would  probably  lead  to  increased  pur- 
chases from  producers  elsewhere,  thus  occasioning 
a  balance  of  indebtedness  against  the  local  banks. 
Sooner  or  later  currency  would  have  to  be  shipped 


LOANS   AND    INVESTMENTS  9 

to  banks  in  other  parts  of  the  country,  and  this 
would  put  a  check  on  further  expansion,  and  might 
make  contraction  necessary.  But  again  if  expan- 
sion of  bank  loans  were  countrywide  this  difficulty 
would  not  be  experienced,  except  from  the  possi- 
bility that  gold  exports  might  be  stimulated,  and 
even  this  contingency  would  not  present  itself  if 
the  expansion  of  credit  were  worldwide.  Finally 
it  should  be  observed  that  even  when  the  expansion 
of  deposits  and  the  increased  drawing  of  checks  are 
confined  to  a  few  banks  they  cause  merely  a  shift- 
ing of  cash  among  the  banks;  it  does  not  diminish 
the  cash  foundation  of  the  credit  structure. 

4.  CASH  AND  CREDIT.— The  conclusions 
regarding  deposits  outlined  above  rest  for  their 
validity  upon  the  assumption  that  the  checks  used 
by  depositors  in  making  payments  are  generally 
received  by  persons  who  deposit  them  to  the  credit 
of  their  own  accounts.  This  is  very  largely  true, 
at  least  in  English  speaking  countries,  in  which 
something  like  90%  of  payments  seem  to  be  made 
with  checks.  For  wages  and  for  a  variety  of  mis- 
cellaneous payments  money  or  bank  notes  are 
required;  but  certainly  an  overwhelmingly  large 
proportion  of  payments  made  with  the  proceeds  of 
bank  loans  are  made  to  persons  who  have  bank 
accounts,  so  that  the  entire  subsequent  series  of 
operations  is  made  without  the  use  of  money,  aside 
from  the  shifting  of  cash  among  the  banks  them- 
selves. But  while  the  creation  of  deposits  by  the 


10         LOANS  AND  INVESTMENTS 

making  of  bank  loans  does  not  involve  an  equiva- 
lent outflow  of  money  from  the  banks,  there  is  a 
direct  connection  between  the  cash  holdings  of  the 
banks  and  their  power  to  extend  credit.  Confidence 
in  the  banks  is  the  foundation  on  which  rests  the 
structure  of  bank  credit,  and  one  important  factor 
in  establishing  and  maintaining  confidence  is  the 
cash  reserve.  Whether  this  store  of  money  is 
largely  held  in  a  single  central  institution,  as  in  most 
European  countries,  or  widely  scattered  among 
many  banks,  as  in  the  United  States,  in  every 
instance  we  find  that  some  more  or  less  definite 
relation  of  money  to  deposit  liability  is  regarded 
both  by  bankers  and  the  public  as  a  necessary  safe- 
guard for  the  structure  of  credit.  In  the  United 
States  a  minimum  ratio  of  reserve  to  deposits, 
at  first  regarded  as  advisable,  was  later  imposed 
upon  the  banks  by  law.  In  no  other  country  are 
banks  subject  to  similar  restriction  upon  their 
operations.  Some  legislation  on  this  matter  was 
doubtless  necessary,  because  in  the  absence  of 
branch  banking,  also  generally  prevented  by  law, 
business  is  conducted  in  this  country  by  many 
thousands  of  banks,  large  and  small,  many  of  which, 
as  our  early  history  made  evident,  were  certain  to 
work  upon  utterly  inadequate  reserves.  This  legal 
remedy,  however  necessary,  has  had  some  unfor- 
tunate consequences.  A  rigid  requirement  of  an 
irreducible  reserve  ratio  deprives  the  banking 
system  of  all  elasticity  beyond  a  certain  point  in 


LOANS   AND    INVESTMENTS          11 

the  granting  of  deposit  credits.  It  has  tended  also 
to  foster  in  the  public  mind  an  exaggerated  idea 
of  the  importance  of  this  one,  and  by  no  means  the 
most  important,  element  of  banking  strength.  As 
a  consequence,  the  maintenance  of  the  reserve  has 
exerted  an  enormous  influence  in  shaping  banking 
practice,  especially  in  the  distribution  of  bank 
resources  among  the  various  classes  of  loans.  This 
insistent  attention  given  to  the  maintenance  of 
reserves  would  have  comparatively  little  effect 
upon  the  lending  operations  of  the  banks,  if  changes 
in  cash  holdings  were  small  and  also  predictable; 
but  for  the  ordinary  bank  this  is  far  from  being 
the  case.  However  universal  the  use  of  checks 
may  be,  the  individual  bank  continues  to  be  subject 
to  variations  in  the  demands  upon  it  for  cash.  A 
bank  can  exert  no  control  over  the  use  its  depositors 
make  of  their  accounts  from  day  to  day;  checks 
deposited  with  it  never  exactly  balance  checks  pre- 
sented for  payment.  There  will  be  wide  variations, 
sometimes  favorable,  sometimes  unfavorable.  In 
the  latter  contingency  reliance  may  be  placed  upon 
a  speedy  change  in  favor  of  the  bank,  especially 
if  this  may  be  presumed  with  some  certainty  from 
knowledge  of  the  customary  action  of  impor- 
tant accounts.  More  positive  action  designed  to 
strengthen  its  cash  holdings,  however,  is  certain 
to  become  necessary  from  time  to  time  in  the  ex- 
perience of  every  bank.  The  requirements .  of 
depositors  will  occasionally  result  in  a  succession 


12          LOANS    AND    INVESTMENTS 

of  unfavorable  balances;  and  further,  every  bank 
must  face  the  possibility  that  unfounded  rumors 
may  subject  it  to  a  run.  It  is  imperative,  therefore, 
that  a  bank  be  able  to  pay  out  large  amounts  of 
money  on  demand  and  also  be  in  position  quickly 
I  to  replenish  depleted  reserves.  Its  assets,  or  at 
least  a  considerable  portion  of  them,  must  be  of 
such  a  character  that  they  can  be  quickly  converted 
into  money. 

5.  ASSETS  MUST  BE  LIQUID.— Liquidness 
of  assets  enables  a  bank  to  meet  the  actual  needs  of 
its  depositors  for  money  and  also  by  giving  con- 
fidence serves  to  limit  withdrawals  to  actual  needs. 
This  is  with  most  people,  and  properly  should  be, 
the  fundamental  basis  for  confidence  in  a  bank.    To 
serve  the  purposes  just  mentioned  the  same  degree 
of  liquidness  in  all  assets  is  not  required.    Imme- 
diate convertibility  into  cash  of  a  portion  of  the 
assets  of  a  bank  is  sufficient  for  the  building  up  of 
reserves  depleted  on  account  of  unusually  large  re- 
quirements on  the  part  of  depositors,  or  even  for  the 
exceptional  contingency  of  a  run  upon  the  bank. 
Experience  shows  that  a  bank  all  of  whose  assets 
can  be  converted  into  cash  within  a  few  months 
without  loss  is  altogether  unlikely  to  be  disturbed 
by  lack  of  confidence,  and  should  it  be  subjected 
to  unfounded  rumors  no  difficulty  is  experienced  in 
securing  the  necessary  funds  from  other  banks. 

6.  LINES    OF    CREDIT.— The    investments 
which  best  meet  the  peculiar  requirements  of  com- 


LOANS    AND    INVESTMENTS          13 

mercial  banks  are  loans  payable  either  on  demand 
or  within  a  few  months,  seldom  more  than  six 
months.  With  a  reasonably  large  number  of  short 
time  loans,  so  selected  that  some  of  them  will  be 
maturing  daily  or  at  least  nearly  every  day,  and  all 
of  them  within  a  six  months  period,  it  might  seem 
at  first  sight  that  if  a  bank  adopted  the  simple  means 
of  refraining  from  making  new  loans,  the  payment 
of  these  loans  would  automatically  provide  a  bank 
with  funds  to  meet  all  ordinary  requirements.  But 
the  problem  which  confronts  the  banker  is  not  of 
this  simple  character,  because  there  are  other  con- 
siderations which  must  be  given  weight  in  handling 
the  loan  account  of  a  bank.  If  a  bank  is  to  continue 
as  a  going  concern  engaged  in  profitable  business  it 
cannot  entirely  discontinue  the  making  of  loans.  It 
holds  its  business  depositors  largely  through  its 
readiness  at  all  times  to  furnish  them  a  reasonable 
amount  of  accommodation.  Within  limits  of  safety 
determined  by  the  character  of  the  depositor,  the 
nature  of  his  business,  the  size  of  his  account  and 
the  size  of  the  bank,  lines  of  credit  have  been  agreed 
upon.  These  agreements  clearly  place  a  part  of  the 
lending  power  and  consequently  a  part  of  the  assets 
of  the  bank  outside  the  field  of  practical  every  day 
liquidness.  For  a  bank  regarded  as  a  going  concern, 
therefore,  a  considerable  proportion  of  its  resources 
are  unavailable  as  a  means  of  strengthening  itself 
for  the  purpose  of  meeting  ordinary  requirements. 
Further,  unless  borrowers  have  in  general  already 


14          LOANS    AND    INVESTMENTS 

fully  utilized  their  lines  of  credit,  the  bank  is  subject 
to  the  possibility  of  additional  demands  for  accom- 
modation, which  it  cannot  refuse  to  grant,  and  which 
may  come  just  at  a  time  when  it  is  meeting  un- 
usually heavy  payments  to  depositors  either  directly 
or  through  unfavorable  balances  with  other  banks. 
Even  in  periods  of  acute  monetary  stringency  it 
must  be  prepared  to  create  new  deposit  liabilities  by 
making  new  loans.  Striking  instances  are  found  in 
the  case  of  those  banks  which  have  accounts  of  stock 
brokers  who  ordinarily  borrow  on  the  market,  or  of 
business  firms  which  place  their  paper  with  many 
banks  through  note  brokers.  It  is  a  common  prac- 
tice, and  one  dictated  by  sound  business  policy,  for 
such  borrowers  not  to  borrow  from  their  own  banks. 
Lines  of  credit  are  kept  open  to  fall  back  upon  when, 
as  may  happen,  it  becomes  difficult,  if  not  impos- 
sible, to  borrow  in  the  open  market.  The  borrower 
has  thus  an  anchor  to  windward.  But,  on  the  other 
hand,  banks  that  have  such  accounts  have  incur- 
red obligations  to  extend  credit  just  when  it  may 
be  most  inconvenient  for  them  to  do  so. 

7.  LIQUIDNESS  OF  LOANS  TO  DEPOSI- 
TORS.— Clearly  then  a  bank  should  have  assets 
more  liquid  than  its  loans  to  its  own  clientele  of 
business  depositors.  The  conclusion  should  not  be 
drawn,  however,  that  the  loans  made  to  such  regular 
customers  need  not  possess  the  quality  of  liquidness. 
The  analysis  in  the  preceding  paragraph  was  con- 
cerned altogether  with  these  loans  taken  as  a  class. 


LOANS   AND    INVESTMENTS          15 

The  individual  loans  within  this  class  must  be  liquid 
to  enable  a  bank  to  extricate  itself  from  threatened 
failure  or  suspension,  contingencies  which  would 
inconvenience  borrowers  far  more  than  the  refusal 
to  allow  them  accommodation  agreed  upon  under 
lines  of  credit.  Moreover,  there  is  another  and  even 
more  important  reason  for  insisting  upon  liquidness 
in  the  case  of  these  loans.  A  large  part  of  the  loans 
made  by  banks  is  based  upon  personal  security 
alone,  promissory  notes  with  or  without  indorse- 
ments. The  underlying  security  rests  very  largely 
upon  the  uses  made  by  the  borrower  of  the  proceeds 
of  these  loans.  If  the  transaction  in  connection  with 
which  the  proceeds  of  the  loan  are  used  will  be  com- 
pleted during  its  life  the  loan  may  be  said  to  pay  for 
itself.  It  is  to  be  presumed  also  that  borrowers  will 
use  the  proceeds  of  loans  which  they  are  to  repay 
in  a  few  months  more  wisely  than  might  be  the  case 
if  the  payment  were  indefinitely  deferred.  More- 
over, conclusions  based  upon  the  analysis  of  the 
statements  of  borrowers  and  upon  other  informa- 
tion are  a  basis  for  short  time  credit  only,  since  over 
a  long  period  conditions  may  change  radically  for 
ic  worse.  Unsecured  loans  must  therefore  as  a 
*  ale  possess  that  quality  of  liquidness  which  comes 
from  short  maturities  to  make  them  a  proper  in- 
vestment for  banks  or  indeed  for  any  lender.  One 
common  method  of  seeking  not  only  to  make  cer- 
tain that  the  loans  made  under  lines  of  credit  shall 
be  liquid,  but  also  to  determine  whether  credit  may 


16          LOANS   AND    INVESTMENTS 

be  safely  continued,  is  to  insist  that  all  borrowing  be 
cleaned  up  at  least  once  a  year.  This  is  often  an 
effective  requirement,  though  it  may  be  more  nomi- 
nal than  real,  since  borrowers  may  simply  allow 
accounts  payable  temporarily  to  pile  up  against 
chem.  The  supply  of  credit  which  the  banks  are  in 
position  to  lend  is,  however,  so  large  that  the  banks 
quite  generally  do  lend  more  or  less  continuously  to 
many  borrowers.  Concerns  whose  business  is 
growing  and  which  show  good  earning  power  are  a 
reasonably  safe  basis  for  such  loans  pending  a  time 
when  they  may  be  expected  to  secure  additional 
capital  by  means  of  more  permanent  obligations,  by 
an  issue  of  additional  capital  stock,  or  by  the  grad- 
ual process  of  putting  profits  back  into  the  business. 
Firms  engaged  in  a  few  lines  of  business  may  per- 
haps be  regarded  as  satisfactory  borrowers  even 
though  they  continue  to  rely  indefinitely  upon 
banks  for  a  part  of  their  working  capital.  In  such 
cases  it  is  essential  that  the  firm  shall  be  engaged 
in  a  business  the  products  of  which  are  in  constant 
demand  and  therefore  readily  saleable  for  cash. 
8.  COLLATERAL  LOANS  TO  DEPOSI- 
TORS.— Based  upon  knowledge  of  the  amount 
of  loans  made  in  former  years,  the  future  needs 
of  regular  commercial  depositors  can  be  fairly  well 
determined;  but,  as  in  the  case  of  the  requirements 
of  depositors  for  cash,  the  estimate  cannot  be  exact, 
and  for  short  periods  may  be  wholly  at  fault.  Evi- 
dently, if  it  is  regularly  to  keep  its  funds  fully  em- 


LOANS   AND    INVESTMENTS          17 

ployed,  a  bank  must  invest  a  part  of  them  in  other 
ways,  in  assets  which  can  be  converted  into  cash 
without  disturbing  valuable  relationships.  The 
banker  may  have  made  a  considerable  number  of 
collateral  loans  to  his  depositors.  The  greater  part 
of  such  are  made  on  the  security  of  stocks  and 
bonds;  and,  leaving  out  of  view  those  made  to 
depositors  who  are  engaged  in  the  business  of  mar- 
keting securities,  these  loans  can  be  allowed  to 
mature  and  new  loans  can  be  refused  with  less 
danger  of  loss  of  accounts  than  in  the  case  of  regu- 
lar commercial  borrowers.  This  is  because  the 
proceeds  of  collateral  loans  are  largely  used  to 
enable  borrowers  to  pay  for  purchases  of  securities 
and  for  other  purposes  outside  their  regular  busi- 
ness. Moreover,  the  borrowers  whose  loans  are 
based  on  readily  marketable  collateral,  can  arrange 
to  borrow  from  other  banks  more  readily  than  is 
generally  true  in  the  case  of  the  commercial  bor- 
rower. 

9.  REDISCOUNTS.  — Few  if  any  banks  are 
likely  to  have  made  these  occasional  loans  to 
depositors  to  such  an  extent  as  to  furnish  them 
speedily  through  contraction  with  a  considerable 
amount  of  funds.  It  is  clearly  necessary,  therefore, 
that  a  bank  invest  a  part  of  its  resources  outside  of 
the  circle  of  its  own  depositors,  unless  it  is  pre- 
pared to  borrow  frequently  from  other  banks.  For 
small  banks,  country  banks  and  those  in  the  small 
cities,  this  has  always  been  quite  feasible  by  means 


18          LOANS   AND    INVESTMENTS 

of  loans  from  their  city  correspondents,  but  it  is 
a  kind  of  business  which  has  not  been  very  largely 
developed  in  this  country.  There  has  been  a  pre- 
judice against  it  among  many  bankers,  who  feel 
that  it  in  some  way  reflects  upon  their  credit.  In 
a  community  in  which  local  requirements  are  at 
certain  seasons  of  the  year  decidedly  greater  than 
the  resources  of  the  local  banks,  it  would  seem  to 
be  a  most  desirable  method  of  raising  funds. 

10.  BANK  BALANCES  AND  BONDS.— Bal- 
ances with  city  banks  in  excess  of  the  amount  which 
can  be  counted  as  a  part  of  the  legal  reserve  are 
another  means  of  providing  funds  to  meet  unusual 
needs.  The  rate  of  return  on  bankers'  balances, 
customarily  2%,  does  not  make  this  a  very  profit- 
able method  of  employing  what  may  be  called  a 
bank's  secondary  reserve,  except  during  periods  of 
monetary  ease  when  rates  for  loans  are  at  a  low 
level.  Bonds  which  are  readily  saleable  may  serve 
this  purpose  also,  but  at  no  little  risk  of  loss.  In 
periods  of  business  inactivity  following  a  crisis, 
bonds  are  indeed  a  very  satisfactory  means  of 
utilizing  some  portion  of  the  resources  of  a  bank. 
They  can  then  usually  be  purchased  at  relatively 
low  prices,  and  if  disposed  of  at  the  beginning  of 
a  period  of  renewed  business  activity  are  likely 
to  have  appreciated  in  value.  In  periods  of  con- 
tinued activity,  however,  bonds  are  likely  to  fall 
somewhat  in  market  price,  and  in  periods  of  general 
strain  may  become  almost  unsaleable.  Bonds  in 


LOANS    AND    INVESTMENTS          19 

general  would  seem  to  be  satisfactory  as  a  special 
investment  to  meet  serious  contingencies  of  par- 
ticular banks  rather  than  as  a  resource  in  periods 
of  general  financial  strain.  If  a  bank  is  threatened 
by  a  run  its  holdings  of  bonds  are  apt  to  prove  a 
more  speedy  means  of  securing  funds  from  other 
banks  than  its  ordinary  loans  to  depositors.  It  may 
also  be  added  that  bonds  are  required  as  security 
for  Government  deposits  and  also  in  many  States 
for  State,  county  and  municipal  deposits.  These 
requirements  explain  the  large  investment  of  many 
banks  in  bonds. 

11.  COMMERCIAL  PAPER.— There  remain 
for  consideration  two  additional  profit  earning 
resources  which  may  be  relied  upon  for  quick  con- 
version into  cash.  There  are  two  classes  of  loans 
insistence  on  payment  of  which,  together  with  the 
refusal  to  make  new  loans,  does  not  subject  a  bank 
to  the  danger  of  the  loss  of  any  business  advantage. 
These  loans  are  commercial  paper  purchased  from 
note  brokers  and  collateral  loans  made  to  stock 
brokers  and  investment  bankers  who  are  not  de- 
positors of  the  lending  bank.  Note  brokers  are 
resorted  to  by  business  concerns  whose  borrow- 
ings are  large,  often  too  large  to  be  granted  by 
one  or  more  banks,  even  by  those  of  the  larg- 
est size.  Banks  purchasing  this  paper  incur  abso- 
lutely no  obligation  to  take  additional  paper  in 
the  future.  They  may  buy  regularly  or  intermit- 
tently, as  suits  their  own  convenience;  the  relation 


20          LOANS   AND   INVESTMENTS 

between  borrower  and  lender  is  absolutely  imper- 
sonal. Commercial  paper  purchased  from  note 
brokers  has  for  many  years  been  a  favorite  avenue 
for  the  employment  of  a  considerable  portion  of 
the  secondary  reserve  of  the  banks.  A  banker  is 
indeed  less  likely  to  know  intimately  the  character 
of  this  paper  than  that  of  loans  made  to  his  own 
depositors.  Here,  however,  the  note  broker,  if 
wisely  selected,  is  a  valuable  safeguard.  It  may  be 
said  without  qualification  that  the  losses  of  banks 
from  commercial  paper  purchased  from  note 
brokers  of  high  standing  have  been  far  less  than 
those  from  loans  to  their  own  depositors,  and  im- 
measurably less  than  those  from  purchases  of  paper 
from  distant  borrowers  made  directly  in  order  to 
save  the  broker's  commission.  The  notes  which 
are  sold  to  the  banks  by  note  brokers  are  generally 
in  round  amounts  of  $5,000  and  in  multiples  of 
$5,000.  Only  very  large  banks  will  have  sufficient 
funds  invested  in  this  way  to  provide  them  with  a 
steady  succession  of  maturities.  For  the  small 
bank,  therefore,  commercial  paper  is  rather  a  means 
of  employing  surplus  funds  which  are  not  likely 
to  be  needed  during  the  continuance  of  the  loan. 
In  this  connection  it  should  be  noted  that  there 
seems  to  be  a  tendency  to  lengthen  the  average 
maturity  of  this  class  of  loans,  owing  to  the  fact 
that  the  borrower  ordinarily  pays  the  same  com- 
mission whether  the  paper  is  to  run  for  three  or 
for  the  maximum  period  of  six  months.  This 


LOANS   AND   INVESTMENTS          21 

longer  average  maturity  lessens  the  value  of  com- 
mercial paper  to  most  banks  as  a  liquid  asset  for 
ordinary  working  purposes. 

12.  LOANS  ON  SECURITIES.— The  favorite 
investment  for  funds  which  may  be  needed  at  any 
moment  is  the  collateral  loan  to  stock  brokers  and 
to  banking  houses  engaged  in  marketing  securities. 
A  part  of  these  loans  is  on  time  and  has  very  much 
the  same  utility  as  a  means  of  employing  banking 
funds  as  commercial  paper  purchased  from  note 
brokers  with  the  further  advantage  that  a  greater 
range  of  maturities  is  available.  There  is  a  broad 
market  for  collateral  loans  maturing  all  the  way 
from  one  month  to  six  months.  A  large  part 
of  the  total  of  collateral  loans  also  is  payable  on 
demand.  Stock  exchange  dealings  and  the  mar- 
keting of  securities  are  unlike  all  other  kinda  of 
business  in  that  they  can  be  in  part  conducted  on 
the  basis  of  call  loans.  The  quick  saleability  of  the 
commodity  handled  makes  this  possible;  conse- 
quently, we  have  here  a  demand  for  loans  under 
such  conditions  as  to  enable  banks  to  make  full  use 
of  their  lending  power  right  up  to  the  limit  set  by 
their  reserve  requirements.  In  the  absence  of  the 
call  loan  it  would  clearly  be  impossible  for  the 
banks  to  keep  their  reserves  intact  and  at  the  same 
time  lend  close  to  the  limit  of  reserve  requirements. 
Many  considerations  must  be  taken  into  account 
in  determining  the  relative  amount  of  its  funds 
which  shall  be  employed  by  a  bank  in  the  various 


22          LOANS   AND    INVESTMENTS 

ways  which  have  been  outlined.  Banks  whose  de- 
posits fluctuate  with  some  degree  of  regularity  can 
naturally  invest  in  a  different  fashion  from  those 
subject  to  large  requirements  which  cannot  be 
foreseen. 

13.  ADJUSTMENT  OF  RESERVES.  —  Let 
us  now  assume  that  a  bank  which  has  invested  in 
all  of  the  various  ways  above  described  finds  itself 
below  reserve  requirements.  From  knowledge  of 
the  tendencies  of  the  accounts  of  its  depositors  it 
may  perhaps  be  reasonably  certain  that  within  a 
few  days  through  deposits  of  cash  or  through  de- 
posits of  checks  giving  it  a  favorable  balance  with 
other  banks  its  reserve  will  be  restored.  Many 
bankers  in  these  circumstances  might  be  content  to 
allow  affairs  to  take  their  own  course.  Others, 
especially  in  cities  where  the  banks  publish  a  weekly 
statement,  would  be  likely  to  call  some  of  their 
demand  loans  but  might  continue  to  purchase  com- 
mercial paper  and  make  time  collateral  loans  to 
an  amount  something  like  current  maturities  of 
such  loans.  If,  however,  there  was  reason  to  be- 
lieve that  depositors  were  likely  still  further  to 
draw  down  their  balances  and  if  demands  for 
further  accommodation  from  depositors  were  to 
be  expected,  a  much  greater  reduction  in  call  loans 
might  be  made  and  at  the  same  time  new  invest- 
ments in  commercial  paper,  and  in  time  collateral 
loans,  might  be  largely  discontinued.  No  one  of 
these  three  kinds  of  loans  would  presumably  be 


LOANS  AND   INVESTMENTS         23 

liquidated  before  a  beginning  was  made  with  the 
other  two.  Some  weight  would  of  course  be  given 
to  the  relative  rates  prevailing  for  each  of  these 
three  kinds  of  loans.  Bonds  would  probably  not 
be  disposed  of  unless  a  pronounced  change  in  the 
conditions  surrounding  the  employment  of  its  funds 
was  foreseen  or  unless  a  bank  were  confronted  with 
a  serious  change  for  the  worse  in  its  affairs.  While 
there  are  neighboring  banks  with  surplus  funds 
to  lend  a  bank  whose  loans  are  liquid  experiences 
no  difficulty  in  securing  additional  funds  by  means 
of  contraction.  Aside  from  loans  to  its  own  de- 
positors, payment  for  which  will  ordinarily  involve 
a  cancellation  of  its  own  deposit  obligations,  it 
is  important  to  observe  that  the  additional  funds 
which  a  bank  thus  secures  come  from  other  banks. 
When  banks  loans  are  paid  by  borrowers,  money 
to  an  insignificant  amount  is  drawn  from  general 
circulation.  The  total  money  holdings  of  the  banks 
are  not  appreciably  increased;  there  is  simply  a 
shifting  of  cash  holdings  among  the  banks. 

14.  GENERAL  CONTRACTION  OF  LOANS. 
— In  periods  of  active  business,  however,  banks  can 
and  generally  do  lend  all  that  their  reserves  will 
support.  If  during  such  a  period  any  considerable 
loss  of  cash  occurs,  the  foundation  of  credit  is 
weakened  and  the  banks  generally  may  desire  to 
strengthen  themselves.  A  policy  of  contraction 
of  loans  may  then  be  adopted  by  most  of  the  banks 
at  the  same  moment.  The  results  of  contraction 


24          LOANS   AND   INVESTMENTS 

in  such  circumstances  are  far  less  effective  in 
strengthening  the  banks  than  those  which  follow 
contraction  by  one  or  a  few  banks.  Just  as  when 
loans  increase  more  checks  are  drawn  in  payment 
for  increased  purchases,  so  when  loans  are  being 
generally  reduced  more  checks  are  drawn  in  favor 
of  the  banks  with  no  corresponding  inflow  of 
money.  The  payment  of  loans  does  not  increase 
the  amount  of  money  in  the  possession  of  the  banks 
taken  as  a  whole;  it  simply  reduces  deposit  obli- 
gations. Let  us  suppose,  for  example,  that  the  New 
York  banks  have  exactly  the  amount  of  reserve 
required  by  law,  18  per  cent,  of  their  net  de- 
posits. One  million  dollars  is  shipped  to  the  in- 
terior, reducing  deposits  by  a  like  amount  and 
reserve  requirements  by  $180,000.  There  is  now 
a  reserve  deficiency  of  $820,000.  Will  the  liquida- 
tion of  $820,000  of  loans  bring  in  the  desired  amount 
of  cash?  By  no  means.  The  loans  will  be  paid 
with  checks  on  the  banks  and  will  reduce  deposits 
by $820,000  and  reserve  requirements  by  18  percent, 
of  that  amount.  In  order  to  restore  the  reserve 
ratio  it  will  be  necessary  to  reduce  loans  by  some- 
thing like  four  times  the  amount  of  cash  loss, 
that  is,  by  four  million  dollars.  It  will  thus  be 
seen  why  the  loan  market  is  at  times  exceedingly 
sensitive  to  a  seemingly  small  loss  of  cash.  When 
surplus  reserves  are  low,  it  may  involve  a  contrac- 
tion of  loans  several  times  the  amount  of  the  cash 
lost.  If  the  cash  lost  is  due  to  gold  exports  the 


LOANS   AND   INVESTMENTS         25 

advance  in  rates  which  is  certain  to  accompany 
general  loan  contraction  may  make  it  profitable  to 
borrow  in  foreign  markets.  Such  borrowings  often 
bring  about  the  cessation  of  a  gold  export  move- 
ment. It  is  seldom  possible,  however,  so  com- 
pletely to  reverse  the  exchanges  by  this  means  as 
to  secure  additional  cash  by  means  of  gold  imports. 
15.  ULTIMATE  EFFECTS  OF  CONTRAC- 
TION.— Ultimately  if  contraction  entails  lessened 
business  activity,  money  will  flow  into  the  banks 
from  general  circulation;  but  this  is  a  slow  and 
uncertain  resource  of  little  use  in  meeting  the 
pressing  needs  which  usually  occasion  the  general 
liquidation  of  loans.  The  reduction  of  deposit 
liabilities  through  contraction  will,  of  course,  bring 
the  reserve  ratio  of  the  banks  to  a  satisfactory 
point  if  it  can  be  carried  far  enough.  But  it  cannot 
be  carried  very  far.  Business  cannot  be  suddenly 
deprived  of  that  amount  of  credit  which  it  has  been 
receiving  without  disastrous  consequences.  When 
the  volume  of  business  declines,  the  volume  of  credit 
can  also  be  correspondingly  reduced  but  not  before, 
except  within  narrow  limits.  The  credit  granted 
to  those  engaged  in  one  of  the  last  stages  of  the 
production  of  some  commodities  can  generally,  it 
is  true,  be  reduced  without  much  difficulty.  Con- 
sider, for  example,  the  meat  and  provision  business. 
Packers  reduce  their  purchases  of  cattle  and  hogs. 
The  necessary  daily  consumption  of  the  people 
soon  reduces  the  stock  on  hand  and  as  cash  pay- 


26          LOANS   AND   INVESTMENTS 

ments  are  the  rule  in  this  line  of  business  the 
packers  will  shortly  be  able  to  liquidate  their  loans 
and  would  require  no  new  accommodation.  It 
seems  at  first  sight  as  if  a  large  amount  of  com* 
.mercial  loans  would  have  been  eliminated.  But 
5  consider  the  situation  of  the  large  number  of 
farmers  engaged  in  the  business  of  raising  cattle 
and  hogs.  Unable  to  sell  as  much  as  usual  to  the 
packers  they  would  be  obliged  to  fall  back  upon 
their  own  banks,  from  which  they  would  be  com- 
pelled to  borrow  more  largely  than  usual.  Even 
call  loans  are  much  less  liquid  than  is  gen- 
erally supposed.  When  a  few  banks  demand  pay- 
ment of  these  loans  brokers  to  whom  they  are 
principally  made  secure  loans  elsewhere  and  the 
banks  calling  the  loans  are  paid.  The  total  volume 
of  call  loans  is  not  much  changed.  Within  narrow 
limits  it  may  be  possible  to  reduce  the  aggregate 
of  such  loans  by  sales  of  securities  to  persons  able 
to  pay  for  them  outright.  It  is  also  possible  to 
secure  additional  margins  from  customers  for 
whom  brokers  are  carrying  securities.  But  when 
all  banks  call  loans  they  soon  cease  to  be  convert- 
ible. Purchasers  who  might  be  able  to  pay  for 
securities  outright  become  frightened,  while  alarm 
and  even  panic  may  become  general.  In  order  to 
prevent  disastrous  failures  among  brokers  and 
consequent  loss  to  themselves  the  banks  find  it 
necessary  to  refrain  from  insisting  upon  general 
loan  contraction. 


LOANS    AND   INVESTMENTS          27 

16.  GENERAL  LOAN  CONTRACTION  TO 
BE  AVOIDED.— In  European  countries  the  banks 
never  find  it  necessary  to  attempt  to  strengthen 
themselves  by  sudden  and  general  contraction  of 
loans.    Slow  contraction  of  loans  is  of  course  some- 
times insisted  upon  when  it  is  thought  that  the 
business  situation  will  thereby  be  improved.     If 
it  is  merely  a  question  of  strengthening  the  banks, 
however,  recourse  is  had  to  the  central  banking 
institutions  found  in  all  European  countries.    Un- 
like other  banks  these  central  banks  in  ordinary 
times  never  lend  to  the  full  extent  of  their  power 
to  grant  credit.     They  are  therefore  always  in 
position  to  take  over  a  part  of  the  load  of  loans 
from  the  other  banks.     This  makes  the  situation 
in  emergencies  in  European  countries  analogous 
to  what  it  has  been  with  us  when  some,  but  not  all, 
of  the  banks  were  seeking  to  strengthen  themselves 
by  means  of  contraction.     It  cannot  be  expected 
that  each  one  of  the  many  thousands  of  banks 
in  this  country  will  reserve  part  of  its  lending 
power  for  emergencies  which  after  all  come  but 
seldom.     Somewhere  in  every  banking  system  a 
reserve  of  lending  power  is  required,  and  it  is 
primarily  to  meet  this  requirement  that  the  Federal 
Reserve  banks  were  established  in  1914. 

17.  ALDRICH-VREELAND    ACT— In  addi- 
tion  to   central   banking   arrangements   there   is 
another   possible   method   of  meeting  emergency 
requirements.     All  banks  may  be  authorized  to 


28          LOANS   AND    INVESTMENTS 

issue  a  special  variety  of  bank  notes  subject  to  a 
tax  onerous  enough  to  deprive  the  banks  of  all 
inducement  to  issue  them  in  ordinary  times.  This 
was  the  method  adopted  in  the  Aldrich-Vreeland 
Act  of  1908.  This  measure  proved  of  the  very 
greatest  advantage  during  the  crisis  of  1914. 
Nearly  $300,000,000  of  the  emergency  notes  were 
issued,  thus  enabling  the  banks  to  meet  all  demands 
for  currency  without  entrenching  upon  their  cash 
reserves,  and  at  the  same  time  to  aid  the  business 
community  by  the  granting  of  additional  accom- 
modation. 

18.  FEDERAL  RESERVE  ACT.— Before  the 
occasion  for  testing  this  legislation,  and  following 
European  example,  the  Federal  Reserve  Act  was 
passed  on  December  23,  1913.  The  Federal  Re- 
serve banks  were  opened  for  business  on  November 
16,  1914,  just  after  the  crisis  of  that  year  had  been 
overcome.  The  primary  purpose  of  the  reserve 
banks  and  the  Aldrich-Vreeland  notes  is  similar. 
Both  were  designed  to  meet  periods  of  severe  finan- 
cial strain,  but  it  is  rightly  believed  that  the  reserve 
banks  will  prove  more  serviceable  for  this  purpose, 
and  that  they  will  also  be  of  much  advantage  in 
ordinary  times.  In  particular,  the  reserve  banks 
are  expected  to  be  able  to  exert  a  restraining  in- 
fluence during  the  periods  of  rapid  credit  expansion 
which  always  precede  crises.  It  is  also  believed 
that  they  will  contribute  much  to  the  standardiza- 
tion of  banking  practice,  and  that  they  will  improve 


LOANS    AND    INVESTMENTS          29 

methods  of  making  settlements  between  the  banks 
in  different  parts  of  the  country. 

19.  RESERVE  BANKS  AND  LIQUIDNESS. 
— If  the  reserve  banking  system  works  well  it  may 
reasonably  be  expected  that  the  course  followed 
by  banks  in  making  adjustments  to  variations  in 
demands  for  cash  will  be  materially  different  from 
what  it  has  been  in  the  past.  It  will  be  just  as 
necessary  as  formerly  for  a  bank  to  keep  itself 
in  a  liquid  condition,  but  the  relative  liquidness  of 
different  classes  of  assets  will  be  somewhat  changed 
and  the  liquidness  of  all  assets  will  be  enhanced. 
The  liquidness  of  all  assets  will  be  enhanced  if  the 
reserve  banks  maintain  themselves  in  a  condition  of 
such  strength  as  to  be  able  at  all  times  to  supply 
additional  credit  and  currency  to  meet  emergencies. 
The  process  of  conversion  of  assets  into  cash  will 
then  be  the  simple  matter  which  we  have  already 
seen  it  to  be  when  only  a  few  banks  experience 
the  need  of  conversion.  The  process  of  conversion 
will  be  a  simple  matter  since  it  will  not  involve 
contraction  but  merely  the  transfer  of  assets  to 
reserve  banks,  in  exchange  for  cash.  Loan  con- 
traction will,  no  doubt,  from  time  to  time  occur 
when  the  volume  of  business  falls  off  or  when  there 
is  evidence  of  an  over-extended  condition  of  affairs. 
Contraction  will  be  carried  through  gradually, 
however,  so  as  to  conserve  all  interests  so  far  as 
may  be  possible.  Contraction  will  not  be  resorted 
to  merely  to  strengthen  the  banks. 


30          LOANS   AND    INVESTMENTS 

20.  RESERVE  BANKS  AND  COMMER- 
CIAL LOANS. — As  an  indirect  consequence  of 
the  operation  of  the  reserve  banks  it  may  be  an- 
ticipated that  all  bank  assets  will  be  more  steadily 
liquid  than  in  the  past.  Bonds,  for  example,  will 
be  more  steadily  saleable,  and  the  possibility  of 
shifting  call  loans  will  be  always  present.  But 
obviously  those  assets  will  gain  most  in  liquidness 
which  can  be  used  as  a  basis  for  loans  from  the 
reserve  banks.  Most  of  the  European  banks  may 
make  loans  of  all  kinds  both  to  individuals  and  to 
banks.  In  the  case  of  the  reserve  banks  the  field 
of  operation  has  been  somewhat  narrowly  pre- 
scribed, though  it  may  be  added  it  includes  those 
classes  of  business  which  make  up  the  bulk  of  the 
investments  of  the  European  central  banks.  The 
normal  lending  operations  of  the  reserve  banks 
are  limited  to  the  purchase  of  commercial  bills  of 
exchange  and  the  rediscounting  for  member  banks 
of  commercial  loans  of  all  kinds  maturing  within 
ninety  days  and  of  agricultural  loans  maturing 
within  six  months.  The  rediscounting  of  loans 
secured  by  stocks  and  bonds  is  specifically  pro- 
hibited. Commercial  loans  are  generally  defined 
in  the  act  as  "notes,  drafts  and  bills  of  exchange 
rising  out  of  actual  transactions.  That  is,  notes, 
drafts  and  bills  of  exchange  issued  or  drawn  for 
agricultural,  industrial,  or  commercial  purposes,  or 
the  proceeds  of  which  have  been  used  or  are  to  be 
used  for  such  purposes."  The  Federal  Reserve 


LOANS   AND    INVESTMENTS          31 

Board  was  authorized  to  define  more  precisely  the 
nature  and  character  of  eligible  paper.  In  the 
exercise  of  this  power  the  Reserve  Board  has  de- 
fined commercial  loans  in  such  a  way  as  to  include 
all  loans  to  borrowers  engaged  in  production  and 
marketing  of  goods  whose  current  liabilities  are 
not  in  excess  of  their  current  assets.  Loans  of 
this  character  are  everywhere  the  backbone  of  the 
banking  business. 

21.  SOURCES  OF  PAYMENT  OF  BANK 
LOANS. — Borrowers  derive  the  means  of  pay- 
ment of  bank  loans  from  a  variety  of  sources. 
The  liquidation  of  many  loans  is  dependent  upon 
the  sale  of  property,  such  as  real  estate  and 
buildings,  or  of  stocks  or  bonds.  Some  loans  are 
gradually  reduced  and  ultimately  paid  in  full  with 
savings  made  from  income  and  especially  from  the 
profits  of  a  business.  The  floating  indebtedness 
of  a  successful  business  may  be  liquidated  by  se- 
curing additional  capital,  either  through  the  issue 
of  new  stock  or  the  sale  of  bonds.  Payment  of 
particular  loans  may  be  accomplished  by  borrowing 
elsewhere  or  by  postponing  the  payment  of  current 
accounts  with  those  from  whom  goods  have  been 
purchased.  Finally,  means  of  payment  may  be 
secured  during  the  life  of  the  loan  as  a  natural 
result  of  the  regular  operations  of  a  business.  In 
the  case  of  particular  loans,  any  one  of  these  various 
means  of  payment  may  be  regarded  as  of  primary 
importance  by  the  banker,  but  the  bulk  of  all  bank 


32          LOANS   AND    INVESTMENTS 

loans  are  based  mainly  either  upon  collateral  or 
upon  the  expected  results  of  natural  business  opera- 
tions. Some  loans  possess  both  these  elements  of 
strength,  but  more  commonly  credit  is  granted 
upon  one  of  them  alone  rather  than  both  in  com- 
bination. 

22.  COLLATERAL    LOANS.— The  business 
of  making  collateral  loans  is  of  a  comparatively 
simple  nature.    The  quality  of  such  loans  depends 
mainly  upon  the  marketability  of  the  collateral 
pledged  as  security.    Of  course  there  may  be  sud- 
den unforeseen  changes  in  the  value  of  any  given 
security;   and  in  periods  of  acute  financial  strain 
there  may  be  a  sharp  decline  in  the  value  of  all 
securities,  and  difficulty  may  be  experienced  in 
finding  purchasers  at  any  price.    Lending  can  never 
be  made  a  routine  mechanical  business.    But  with- 
out minimizing  the  hazards  involved  in  making 
collateral  loans,  it  is  certain  that  the  problems  en- 
countered in  making  loans  based  on  the  current 
results  of  business  operations  are  far  more  numer- 
ous and  complicated. 

23.  COMMERCIAL     LOANS.  —  Loans,  the 
means  of  payment  of  which  become  available  dur- 
ing the  life  of  the  loan  as  a  result  of  the  regular 
operations  of  a  business,  are  commonly  known  as 
"commercial  loans."    The  instrument  in  which  the 
obligation  is  embodied  may  be  either  a  bill  of 
exchange  or  a  promissory  note.    The  lender  may 
rely  for  payment  upon  the  borrower  alone  or  re- 


LOANS   AND    INVESTMENTS          33 

quire  additional  security — either  a  lien  on  tangible 
property  or  the  endorsement  of  one  or  more  third 
parties.  There  is,  then,  much  variety  among  com- 
mercial loans,  but  they  all  possess  one  feature  in 
common  which  overshadows  these  differences.  To 
be  a  commercial  loan,  the  proceeds  must  be  used 
in  financing  the  production  and  marketing  of  goods, 
operations  from  which  the  means  of  payment  will 
ordinarily  be  derived  before  it  matures.  The  limits 
within  which  banks  may  safely  finance  these  opera- 
tions, and  the  terms  on  which  accommodation  shall 
be  granted,  constitute  the  complex  problem  of  the 
commercial  loan.  The  financing  of  fixed  assets — 
land,  buildings,  and  machinery — is  entirely  outside 
the  limits  of  commercial  borrowing.  No  part  of 
the  indebtedness  of  a  borrower  in  excess  of  his 
current  assets  can  be  regarded  as  commercial  in 
character.  Moreover,  to  finance  anything  like  all 
of  current  assets  by  means  of  short  time  loans 
would  in  almost  all  instances  involve  the  speedy 
insolvency  of  the  borrower  and  loss  to  the  banks. 
24.  CURRENT  ASSETS.— Current  assets  con- 
sist of  materials,  work  in  process,  finished  goods, 
accounts  and  notes  receivable,  and  cash.  In  the 
ordinary  course  of  business  all  the  other  current 
assets  are  in  process  of  conversion  through  one  or 
more  stages  into  cash.  At  the  same  time,  however, 
it  is  to  be  noted  that  unless  a  business  is  being 
wound  up,  new  current  assets  of  each  kind  are  con- 
stantly being  acquired.  The  materials  of  today 


34          LOANS   AND    INVESTMENTS 

become  the  finished  goods  of  tomorrow  and  the 
receivables  of  a  more  distant  future.  Current  assets 
are  revolving  assets. 

25.  CURRENT  LIABILITIES.— An  analogous 
process  is  to  be  observed  in  the  current  obligations 
of  a  business.    Indebtedness  to  banks  and  to  those 
from  whom   goods  are  purchased  is  constantly 
maturing  and  being  paid,  but  new  obligations  are 
at  the  same  time  being  incurred  in  connection  with 
the  operations  which  will  result  in  future  sales. 
There  must  be  a  constant  inflow  of  cash  to  a  busi- 
ness to  meet  these  obligations  as  they  become  due, 
and  this  inflow  must  be  sufficient,  not  merely  for 
this  purpose,  but  also  to  provide  for  the  current 
running  expenses  of  the  business,  to  say  nothing  of 
provision  for  up-keep  and  earnings.    But  since  new 
obligations  are  constantly  being  created,  there  is 
always  the  possibility,  in  the  case  of  a  business 
which  is  losing  ground,  that  an  inadequate  inflow 
of  cash  is  being  met  by  using  proceeds  of  new  cur- 
rent obligations  to  meet  the  burdens  of  the  past 
rather  than  the  operations  of  the  future.     Since 
business  is  a  continuing  process,  it  cannot  be  con- 
stantly subjected  to  the  test  of  complete  liquidation 
of  its  indebtedness.    The  supply  of  cash,  therefore, 
may  be  sufficient  to  meet  maturing  obligations  for 
a  considerable  time  after  a  concern  is  in  an  unsound 
or  even  insolvent  condition. 

26.  METHODS  OF  DETERMINING  SAFE 
LIMITS  OF  CURRENT  LIABILITIES.— Two 


LOANS    AND    INVESTMENTS          35 

methods  of  determining  whether  the  current  liabili- 
ties of  a  business  are  being  kept  within  safe  limits 
may  be  distinguished.  Under  one  method  credit 
is  based  upon  the  entire  financial  position  of  the 
borrower  as  determined  by  the  analysis  of  state- 
ments of  the  condition  of  his  business  and  other  in- 
formation. Under  the  other  method  specific  trans- 
actions, purchases  and  sales  of  goods,  measure 
borrowing  capacity.  Before  considering  the  respec- 
tive merits  of  these  two  methods,  it  is  to  be  noted 
that  neither  of  them  has  validity — indeed,  they 
may  be  positively  misleading — in  the  absence  of 
character  and  business  ability  in  the  borrower.  The 
most  prosperous  business  may  be  quickly  ruined 
through  mismanagement.  Under  no  method  of 
determining  proper  limits  for  loans  can  the  pos- 
sibility of  loss  through  dishonesty  be  entirely 
eliminated.  Judgment  of  men  is  fundamentally 
essential  for  the  successful  conduct  of  commercial 
banking.  But  definite  rules  and  principles  for  esti- 
mating the  character  and  capacity  of  individuals 
are  of  little  service.  In  the  final  analysis,  there- 
fore, it  will  simply  be  assumed  that  the  banker 
has  satisfied  himself  regarding  these  essential 
qualifications. 

27.  STATEMENTS  OF  BORROWERS.— The 
honesty  of  the  borrower  is  especially  important 
when  statements  of  the  condition  of  his  business 
are  used  in  determining  the  amount  of  credit  which 
may  safely  be  granted.  An  independent  audit  of 


36          LOANS    AND    INVESTMENTS 

course  reduces  the  danger  from  fabricated  state- 
ments, and  such  audits  are  becoming  increasingly 
common,  although  they  can  hardly  be  expected  in 
the  case  of  borrowers  of  small  or  medium  size.  The 
practice  of  requiring  a  statement  of  condition  from 
borrowers  has  grown  during  the  last  twenty  years 
until  now  it  is  almost  universal  in  well-managed 
banks.  It  is  evidently  an  imperatively  necessary 
requirement  where  credit  is  granted  on  unsecured 
single  name  paper.  Statements  of  condition  are 
made  with  varying  degrees  of  completeness.  Often 
only  a  balance  sheet  is  available,  but  frequently  a 
statement  of  the  amount  of  sales  is  also  given,  as 
well  as  other  information.  The  balance  sheet  alone 
is  commonly  the  only  information  furnished  pur- 
chasers of  commercial  paper  from  note  brokers. 
Borrowers  naturally  are  unwilling  that  detailed 
information  regarding  their  affairs  should  be  spread 
broadcast  throughout  the  country.  To  the  note 
broker,  however,  more  complete  information  in 
confidence  is  commonly  given.  When  balance 
sheets  alone  are  available  intimate  knowledge  of 
the  industry  in  which  the  borrower  is  engaged  is 
needed  in  order  to  interpret  them.  The  relative 
amount  of  various  kinds  of  current  assets  and  lia- 
bilities shown  in  the  balance  sheet  when  compared 
with  statements  of  others  engaged  in  the  same  line 
of  business  will  often  indicate  whether  it  is  in  a 
sound  or  weak  condition.  A  single  balance  sheet 
is  of  very  little  significance,  but  a  series  of  state- 


LOANS   AND    INVESTMENTS          37 

ments  extending  over  a  period  of  years  often  throws 
much  light  upon  the  conditions  and  tendencies  of 
a  business. 

28.  RATIO    OF    CURRENT    ASSETS    TO 
LIABILITIES.— It  is  a  common  rule  of  thumb 
that  current  assets  ought  to  be  twice  the  amount 
of  current  liabilities.    This  is  not  a  rule  for  lending 
that  should  be  followed  blindly;    it  is  merely  a 
suggestion,  a  sort  of  guidepost.    If  the  current  lia- 
bilities are  more  than  one-half  the  assets  it  naturally 
puts  the  banker  on  inquiry  to  find  out  whether  the 
rather  high  proportion  of  current  liabilities  to  cur- 
rent rent  assets  is  safe.    A  proportion  of  !*/£  to  1 
may  in  certain  lines  of  business  be  a  more  satisfac- 
tory proportion  than  a  2y2  or  3  to  1  proportion  in 
other  kinds  of  business. 

29.  LIQUIDATION     OF    ASSETS.  — It    is 
necessary,  therefore,  to  know  a  good  deal  about 
the  nature  of  different  kinds  of  business  if  one  is 
to  grant  credit  wisely.    There  are  some  kinds  of 
business  the  products  of  which  are  universally  con- 
sumed and  paid  for  in  cash.    Concerns  engaged  in 
such  business  obviously  can  borrow  more  largely, 
and  can  go  along  with  a  lower  ratio  of  assets  to 
liabilities,  than  those  engaged  in  other  kinds  of 
business.    Take  a  business  like  that  of  the  packers, 
for  instance,  who  are  large  borrowers  through  note 
brokers.    It  would  be  possible  for  such  concerns  to 
liquidate  many  millions  of  dollars  in  a  compara- 
tively short  time.   All  they  would  need  to  do  would 


38          LOANS   AND    INVESTMENTS 

be  to  purchase  in  the  near  future  a  smaller  number 
of  cattle  and  hogs.  The  demand  for  their  products 
would  quickly  take  off  the  existing  supply  and  they 
would  largely  be  paid  in  cash.  Moreover,  they 
would  lose  no  valuable  trade  connections  by  cur- 
tailing operations,  and  possibly  they  might  take 
advantage  of  the  situation  to  add  a  few  cents  to 
the  price  of  their  products. 

30.  SLOW  LIQUIDATION.— Let  us  consider 
another  kind  of  business,  say  a  furniture  manufac- 
turer. It  might  be  that  just  at  the  time  when  he 
would  like  to  reduce  his  obligations  his  obligations 
will  increase.  Let  us  suppose  circumstances  in 
which  the  demand  for  furniture  suddenly  falls  off 
on  account  of  general  reaction  in  the  activity  of 
trade.  Dealers  in  furniture  would  in  those  circum- 
stances purchase  less  than  the  expected  supply  of 
'furniture,  and  presumably,  also,  they  would  defer 
more  or  less  their  payments  on  past  purchases.  In 
the  meantime  the  maker  of  furniture  would  find 
himself  loaded  up  with  a  large  amount  of  it,  for 
the  moment  unsalable,  and  he  would  have  no  one 
on  whom  he  could  fall  back,  as  was  the  case  with 
the  dealer.  Of  course,  the  furniture  maker  might 
defer  payments  for  materials  to  a  certain  extent, 
but  the  value  of  the  materials  going  into  furniture 
is  small  as  contrasted  with  the  value  of  the  furni- 
ture itself,  as  so  much  of  the  value  of  that  product 
is  due  to  the  labor  employed  upon  the  material.  On 
this  account  the  delay  on  the  part  df  the  furniture 


LOANS   AND    INVESTMENTS          39 

maker  in  meeting  his  payments  for  purchases  would 
not  by  any  means  offset  delays  on  the  part  of  fur- 
niture dealers  in  making  payments  to  makers  of 
furniture.  Clearly,  then,  the  furniture  maker  is  a 
concern  from  which  one  would  demand  a  higher 
ratio  of  quick  assets  to  quick  liabilities  than  from 
a  packing-house  concern.  In  a  general  way  it  may 
be  said  that  those  engaged  in  the  last  stages  of 
production,  if  they  are  producing  an  article  which 
enters  into  necessary  and  general  consumption,  can 
extricate  themselves  from  critical  credit  situations 
more  easily  than  any  other  class  of  producers  in 
the  community. 

31.  VOLUME  OF  SALES.— In  the  interpreta- 
tion of  balance  sheets  the  amount  df  net  sales  is 
of  great  assistance.  A  rapid  turn-over  of  current 
assets,  as  compared  with  that  of  others  engaged 
in  the  same  line  of  business,  is  ordinarily  an  indica- 
tion of  a  capable  and  successful  management.  It 
implies  that  stocks  are  wisely  purchased;  it  also 
indicates  that  dead  stock  is  not  inflating  the  inven- 
tory, and  that  accounts  long  past  due  are  not  being 
carried.  An  absolutely  high  turn-over  is  also  sig- 
nificant. Here  there  is  a  wide  variation  owing  to 
differences  in  the  nature  of  various  lines  of  business. 
The  process  of  production  may  be  long,  or  the 
terms  of  payment  may  be  customarily  liberal,  as  in 
the  case  of  agricultural  implements.  Where  these 
conditions  are  found  the  ratio  of  current  assets  to 
current  liabilities  should  be  high — in  other  words, 


40          LOANS   AND   INVESTMENTS 

a  large  part  of  the  current  assets  should  be  financed 
by  those  conducting  the  business. 

32.  LIMITED    SIGNIFICANCE    OF    BAL- 
ANCE   SHEETS.  — All  the  information  derived 
from  balance  sheets  and  other  sources  is  designed 
to  determine  the  liquidating  ability  of  borrowers. 
From  balance  sheets,  however,  this  ability  can  only 
be  inferred.   A  balance  sheet  simply  presents  a  more 
or  less  accurate  statement  of  the  condition  of  a 
business  at  some  one  moment  of  time.    It  does  not 
give  any  assurance  of  the  ability  of  a  concern  to 
meet  its  obligations  as  they  mature.     It  is  quite 
possible,  however,  to  secure  information  about  a 
business  which  will  give  a  clear  and  direct  indica- 
tion of  its  liquidating  possibilities.    Moreover,  this 
can  be  done  without  divulging  information  which 
might  prove  helpful  to  competitors.    This  method 
of  estimating  liquidness  is  also  extremely  simple, 
but  it  has  as  yet  been  applied  by  only  a  few  lenders. 

33.  RATIO    OF   COLLECTIONS   TO    MA- 
TURITIES.— As  we  have  already  seen,  the  inflow 
of  cash  to  a  solvent  business  must  be  sufficient  to 
meet  its  various  maturities  and  all  the  other  ex- 
penses of  the  business,  and  in  the  case  of  a  pros- 
perous concern,  there  must  be  something  left  for 
profits.    A  high  ratio  in  cash  receipts  to  the  pay- 
ments which  must  be  met,  evidently,  then,  affords 
the  strongest  possible  basis  'for  the  conclusion  that 
a  business  will  be  able  to  liquidate  its  obligations 
in  the  future.    Suppose,  for  example,  that  during 


LOANS   AND    INVESTMENTS          41 

the  two  previous  years  the  average  monthly  collec- 
tions of  a  given  manufacturing  business  have  been 
$100,000 ;  that  the  average  monthly  maturities  have 
been  $50,000,  and  average  payments  on  account  of 
rent,  interest,  insurance,  taxes  and  office  salaries, 
have  been  $30,000.  By  the  discontinuance  of  its 
manufacturing  operations  it  is  certain  that  this 
concern  could  liquidate  its  indebtedness  unless 
there  should  be  a  most  severe  falling  off  in  the 
demand  for  its  product.  As  in  the  analysis  of  the 
balance  sheet,  account  would  necessarily  be  taken 
of  the  nature  of  the  business.  A  higher  margin  of 
collections  would  be  requisite  in  some  industries 
than  in  others.  This  method  of  testing  credit  does 
not  take  the  place  of  balance  sheets  and  other 
sources  of  information.  It  simply  supplements 
them,  though  it  is  believed  that  in  the  course  of 
time  this  ratio  between  collections  and  maturities 
and  fixed  charges  will  come  to  be  regarded  as  the 
most  important  single  factor  in  credit  analysis. 

34.  CREDIT  ANALYSIS  AND  SINGLE 
NAME  PAPER.— Analysis  of  the  financial  posi- 
tion of  the  borrower  is  clearly  a  necessary  safeguard 
in  granting  credit  when  a  bank  relies  for  payment 
solely  upon  the  unsecured  notes  of  the  borrower. 
Under  a  system  of  adequate  credit  analysis  a  bank 
is  able  to  determine  with  a  reasonable  degree  of 
certainty  not  only  that  the  borrower  is  using  the 
proceeds  of  his  loans  to  finance  current  assets,  but 
that  also  the  amounts  of  loans  are  within  his 


42          LOANS   AND    INVESTMENTS 

liquidating  capacity.  In  these  two  respects,  at 
least,  single  name  paper  can  be  quite  as  satisfactory 
as  any  other  method  of  borrowing. 

35.  TRADE  PAPER.— Obligations  of  the  pur- 
chasers  of   goods   to   sellers   have   always   been 
regarded  as  a  solid  basis  for  bank  credit.    The  ob- 
ligation may  be  expressed  either  in  the  form  of  a 
note  given  by  the  purchaser  and  endorsed  by  the 
seller,  or  as  a  bill  of  exchange  drawn  by  the  seller 
and  accepted  by  the  buyer.     There  is  no  funda- 
mental legal  difference  between  these  two  instru- 
ments.   The  principal  advantage  possessed  by  the 
bill  is  that  as  the  initiative  is  taken  by  the  seller, 
it  may  be  sent  with  bills  of  lading  attached  through 
a  bank  with  instructions  to  retain  the  ladings  until 
the  bill  has  been  accepted  or  paid.  ' 

36.  TRADE  AND  SINGLE  NAME  PAPER 
COMPARED.  —  The    commercial    character    of 
trade  paper  is  obviously  more  directly  evident  than 
in  the  case  of  single  name  paper.    Names  of  two 
concerns    engaged    in    businesses    which    would 
naturally  make  one  a  purchaser  of  the  product  of 
the  other,  provide  fair  evidence  that  the  paper  is 
commercial  in  character.     In  the  case  of  single 
name  paper  it  becomes  necessary  to  analyze  the 
assets   and  liabilities   of  the  borrower,   but  this 
method,  though  indirect,  offers  equally  clear  evi- 
dence of  the  nature  of  the  transaction.     Double 
name  paper  is  not  infrequently  accommodation 
paper,  and  this  fact  is  not  always  evident.    In  cer- 


LOANS    AND    INVESTMENTS          43 

tainty  that  a  loan  is  commercial  in  character  there 
is  no  appreciable  difference  between  single  and 
double  name  paper.  The  respective  merits  of  the 
two  methods  o{  borrowing  must  clearly  be  de- 
termined by  other  considerations.  At  first  sight 
it  might  seem  that  the  risk  of  loss  to  lenders  must 
be  less  where  trade  paper  is  the  basis  for  loans. 
Tradition  is  all  in  favor  of  the  specific  transaction, 
and  at  first  sight  it  would  seem  self-evident  that  if 
the  maker's  own  note  is  good  the  addition  of  an- 
other signature  could  hardly  fail  to  make  it  still 
better.  This  conclusion,  though  equally  true  in 
the  case  of  any  single  loan,  does  not  necessarily 
hold  good  when  the  character  of  all  current  busi- 
ness obligations  is  to  be  determined.  The  two 
kinds  of  borrowing  are  the  outcome  of  different 
methods  of  conducting  business.  That  method  of 
lending  which  is  most  conducive  to  the  mainte- 
nance of  sound  and  healthy  conditions  in  trade  and 
industry  will,  in  final  anaylsis,  provide  a  superior 
quality  of  commercial  loan. 

37.  CASH  PAYMENTS.— Single  name  paper 
and  the  bank  acceptance  have  to  an  increasing 
extent  taken  the  place  of  double  name  mercantile 
paper  all  over  the  world,  except  in  France,  where 
three  names  are  required  at  the  Bank  of  France, 
The  payment  of  cash  for  commodities  has  brought 
this  change  about.  In  some  lines  of  business,  be- 
cause of  the  marketable  nature  of  the  product,  and 
in  others  because  of  the  strong  position  of  pro- 


44          LOANS    AND    INVESTMENTS 

ducers,  cash  payments  have  been  insisted  upon.  In 
many  other  lines  of  business  the  obvious  advantage 
of  speedy  payment  has  been  sufficient  to  lead  to 
the  offer  of  discounts  for  cash  much  above  ordinary 
rates  for  bank  loans.  When  purchasers  pay  cash, 
obviously  the  double  name  mercantile  bill  or  in- 
dorsed note  cannot  come  into  existence.  Pur- 
chasers must  either  have  enough  capital  of  their 
own  to  make  payments  or  must  borrow  directly 
from  their  banks. 

38.  ADVANTAGES  OF  TRADE  ACCEPT- 
ANCES.— There  is  a  sharp  difference  of  opinion 
at  the  present  time  among  bankers  with  regard  to 
the  respective  merits  of  single  name  paper  and  the 
trade  acceptance.  The  advantages  of  trade  paper 
have  been  ably  presented  by  B.  D.  Harris,  Vice- 
President  of  the  National  City  Bank  of  New  York, 
who  says:  "Under  our  present  account  system  the 
merchant  is  compelled  to  conduct  the  operations 
of  his  business  involving  carrying  the  accounts  of 
his  customers  to  an  unreasonable  extent.  He  is 
compelled  to  do  this  usually  solely  on  his  own 
credit  and  through  the  medium  of  his  single  name 
paper  discounted  with  his  bankers  or  sold  through 
brokers  in  the  open  market.  Owing  to  lack  of 
accurate  knowledge  or  visible  means  6f  knowing 
the  character  of  credits  extended  by  him — and  to 
the  inconvertibility  of  the  latter — it  has  come  to 
be  quite  a  settled  principle  that  in  order  to  have 
a  satisfactory  credit  footing  his  statements  should 


LOANS   AND   INVESTMENTS          45 

show  a  large  margin  of  safety  in  quick  assets  of 
this  character  over  liabilities — usually  in  the  pro- 
portion of  two  for  one,  or  more.  No  matter  how 
sound  his  credits,  he  must  preserve  this  proportion 
to  float  his  single  name  paper  successfully,  whereas 
were  these  credits  converted  into  liquid  double 
name  paper  through  the  medium  of  acceptances 
or  notes,  if  all  conditions  were  sound  they  would 
be  immediately  available  and  all  this  large  degree 
of  lost  motion  eliminated.  If  they  were  unsound 
or  of  inferior  quality,  it  would  become  manifest, 
with  the  result  of  properly  curtailing  his  credit 
accordingly.  For  that  reason  merchants  would  be 
more  careful  in  extending  credits  to  customers, 
there  would  be  less  loss  and  fewer  failures;  it 
would  to  a  large  extent  correct  an  evil  which  has 
come  frequently  under  my  observation,  viz.:  that 
in  active  competition  of  business  many  wholesalers 
and  jobbers  extend  unreasonable  lines  of  credit  to 
a  certain  class  of  small  retail  merchants,  particu- 
larly in  small  country  towns,  who  operate  princi- 
pally on  the  credit  extended  them  by  rival  firms, 
and  with  little  or  no  visible  capital  of  their  own. 
This  means  slow  collections  and  bad  debts,  and  this 
class  of  customers  invariably  assign  short  crops, 
poor  collections,  the  European  war,  or  any  other 
conceivable  excuse,  which  may  seem  most  plausi- 
ble, for  their  inability  to  pay,  and  have  to  be  carried 
over.  It  would  strongly  curb  the  pernicious  prac- 
tice of  over-selling  and  over-buying.  Buyers, 


46          LOANS   AND    INVESTMENTS 

knowing  that  their  obligations  would  be  discounted 
and  their  credit  put  to  the  test,  would  be  more  alive 
to  the  necessity  of  meeting  their  obligations; 
would  be  more  prudent  in  selling  on  credit;  more 
careful  in  taking  on  no  larger  lines  of  merchandise 
than  they  could  sell;  more  certain  of  their  collec- 
tions, and  therefore  more  able  to  pay  their  debts. 
Hence  the  curse  of  over-expansion,  and  the  grow- 
ing mass  oif  credits  which  do  not  liquidate  at  times 
and  seasons  when  they  should  liquidate,  would 
receive  a  salutary  check.  The  strain  on  the  mer- 
chants and  bankers  would  be  diminished,  and  the 
credits  of  the  entire  country  placed  on  a  safer  and 
sounder  footing." 

39.  ADVANTAGES  OF  SINGLE  NAME 
PAPER.— That  these  desirable  results  will  cer- 
tainly follow  the  re-introduction  of  the  use  of  trade 
paper  is,  however,  not  universally  admitted.  In 
favor  of  single  name  paper  the  following  argu- 
ments are  advanced:  "Business  is  altogether  likely 
to  be  kept  in  a  stronger  condition  when  cash  pay- 
ments are  the  rule  than  when  each  producer  and 
dealer  owes  for  \yhat  he  has  bought  and  is  owed 
for  what  he  has  sold.  Many,  nay  most,  men  are 
so  constituted  that  in  periods  of  active  business 
and  general  optimism  they  will  buy  far  more  on 
credit  than  they  would  have  bought  if  required  or 
expected  to  pay  cash.  Mercantile  credit  is  far  more 
likely  to  be  extended  beyond  safe  limits  than  bank 
credit,  partly  because  the  rate  of  return  on  sales 


LOANS    AND    INVESTMENTS          47 

is  greater  than  that  on  bank  loans,  and  even  more 
because  bankers,  comparatively  speaking,  are  a 
highly  conservative  class  of  business  men.  Where 
purchasing  ability  is  limited  by  cash  payments,  it 
is  to  be  expected  that  the  danger  of  a  generally 
overextended  condition  of  business  will  be  some- 
what lessened.  Even  where  cash  discounts  are  not 
taken,  dealers  selling  goods  to  numerous  pur- 
chasers scattered  over  a  wide  territory  would  find 
the  handling  of  mercantile  bills  and  notes  far  more 
expensive  and  troublesome  than  book  accounts 
and  direct  borrowing  from  the  banks.  Moreover, 
on  account  of  the  various  explicit  or  implied  war- 
ranties generally  customary  when  goods  are  sold 
from  samples  by  traveling  salesmen,  many  bills 
and  notes  would  not  be  negotiable  instruments,  and 
would  therefore  be  unavailable  for  discounting 
purposes.  When  this  problem  is  considered  from 
the  standpoint  of  the  banks  the  same  conclusion 
emerges.  If  credit  is  based  upon  specific  transac- 
tions, there  is  no  means  of  determining  whether 
the  amount  of  borrowing  on  the  sales  made  hasj 
been  kept  within  safe  limits,  having  regard  both 
to  the  character  of  the  purchasers  and  to  the  obli- 
gation of  the  borrowers  to  those  from  whom  they 
have  purchased.  Many  notable  failures  in  banking 
history  have  been  due  to  excessive  discounts  of 
paper  representing  actual  sales  of  commodities, 
because  purchasers  had  overbought  and  the  bor- 
rowing sellers  were  overburdened  with  obligations 


48          LOANS    AND    INVESTMENTS 

on  account  of  what  they  themselves  had  purchased. 
Borrowing  on  sales  made  on  a  time  basis  creates 
contingent  liabilities,  and  notoriously,  contingent 
liabilities  are  likely  to  be  regarded  as  no  liability  at 
all.  Cash  payments  tend  to  diminish  the  contingent 
obligations  of  borrowers.  They  free  the  banks  to 
a  large  extent  from  the  necessity  of  going  behind 
the  borrower  to  the  persons  to  whom  he  has  sold 
his  product.  In  the  early  years  of  the  evolution 
of  borrowing  on  single  name  paper  it  was  perhaps 
less  safe  than  double  name  paper.  As  the  practice 
has  become  more  general,  statements  from  bor- 
rowers and  credit  analysis  have  become  customary, 
and  they  are  proving  potent  safeguards.  Grad- 
ually a  more  exact  knowledge  of  the  limits  within 
which  credit  can  be  safely  granted  to  particular 
persons  and  in  different  lines  df  business  is  being 
developed.  This  knowledge  can  never  be  developed 
satisfactorily  if  the  specific  transaction  is  made 
the  basis  for  credit.  Much  of  course  remains  to 
be  done  in  the  field  of  credit  analysis,  and  the  devel- 
opment of  more  systematic  and  frequent  business 
statements." 

40.  DANGER  FROM  BORROWING  IN 
BOTH  WAYS.  —  Experience  alone  can  decide 
when  opinions  so  radically  unlike  are  advanced  with 
reference  to  the  respective  advantages  of  single 
name  paper  and  the  bank  acceptance.  It  may, 
however,  be  stated  with  confidence  that  either  of< 
these  methods  of  borrowing  alone  is  far  more 


LOANS   AND    INVESTMENTS          49 

satisfactory  than  both  in  combination.  If  a  bor- 
rower discounts  trade  acceptances  the  quality  of 
his  single  name  paper  must  evidently  be  changed 
for  the  worse.  In  discounting  his  trade  paper  the 
borrower  has  hypothecated  the  main  source  from 
which  cash  flows  into  his  business.  During  the 
immediate  future  while  both  methods  of  borrowing 
are  being  tested,  the  banker  must  carefully  guard 
against  the  danger  that  many  concerns  will  attempt 
to  borrow  in  both  ways. 

41.  BANK  ACCEPTANCES.— A  bank  accept- 
ance is  a  bill  of  exchange  drawn  on  and  accepted 
by  a  bank.  It  is  a  method  of  borrowing  which 
possesses  many  of  the  advantages  of  both  single 
name  paper  and  the  trade  bill.  National  banks, 
under  an  amendment  to  the  Federal  Reserve  Act 
passed  in  1916,  are  permitted  to  accept  not  only 
foreign  bills  but  also  domestic  bills,  accompanied 
by  shipping  documents  or  secured  by  goods  in 
warehouses,  or  a  lien  on  goods  sold.  In  a  number  of 
the  States  trust  companies  and  State  banks  are  also 
permitted  to  enter  the  acceptance  field.  The  bank 
acceptance  is  unlike  the  trade  acceptance  in  many 
important  respects.  The  accepting  bank  bases  its 
readiness  to  accept  upon  very  much  the  same  con- 
siderations which  are  taken  into  account  in  dis- 
counting single  name  paper — the  character  and 
financial  position  of  the  borrower,  as  shown  by 
financial  statements  and  other  information.  It  is, 
however,  by  no  means  certain  that  the  bank 


50          LOANS    AND    INVESTMENTS 

acceptance  will  come  to  be  commonly  used  in 
domestic  business  in  this  country.  In  Germany  it 
is  a  method  of  borrowing  favored  both  by  banks 
and  the  business  community.  In  other  countries, 
notable  England,  the  use  of  the  bank  acceptance 
is  confined  almost  entirely  to  foreign  business. 
This  difference  in  banking  practice  is  apparently 
in  large  measure  a  consequence  of  differences  in 
the  available  supply  of  funds  at  the  disposal  of 
banks.  In  England,  where  the  supply  of  funds! 
which  the  banks  would  willingly  employ  in  do- 
mestic commercial  loans  has  far  exceeded  the 
demand,  the  banks  have  naturally  preferred  to  dis- 
count rather  than  to  accept  for  their  customers. 
A  similar  disinclination  among  bankers,  coupled 
with  the  greater  complexity  of  acceptance  arrange- 
ments, as  contrasted  with  the  discount  of  notes 
and  payment  by  checks,  will  work  against  the 
general  adoption  of  the  bank  acceptance  in  do- 
mestic business  in  this  country.  In  parts  of  the 
country  where  the  lending  capacity  of  the  banks 
is  insufficient  to  meet  local  requirements,  it  is  not 
unlikely  that  much  use  may  be  made  of  the  bank 
acceptance.  The  acceptance  of  a  bank  gives  to 
the  obligation  a  currency  which  neither  trade  bills 
nor  single  name  paper  can  contain.  The  purchase 
of  acceptances  may  well  prove  a  profitable  and 
satisfactory  investment  for  banks  in  those  parts 
of  the  country  where  there  is  regularly  a  surplus 
of  available  funds. 


CHAPTER  II 

Agricultural  Loans 

42.  COMMODITY  PAPER.  —  Agricultural 
loans  are  not  essentially  different  from  industrial 
loans.  Both  are  made  to  assist  in  producing  ma- 
terial for  market,  although  farm  products  are,  for 
the  most  part,  not  ready  for  human  consumption 
when  they  leave  the  grower's  hands,  but  form  the 
basis  for  industrial  operations  that  make  them 
usable.  Farming  with  live  stock  raising  is  the 
characteristic  occupation  of  this  country,  and  this 
is  recognized  by  the  Nation  and  the  various  States 
in  the  creation  of  agricultural  departments  in  their 
plans  of  administration,  by  the  establishment  of 
agricultural  colleges,  and  by  various  special  enter- 
prises intended  to  promote  better  farming.  The 
Federal  Reserve  Act  and  rulings  of  the  Federal 
Reserve  Board  wisely  contain  provisions  granting 
special  privileges  to  agricultural  and  live  stock 
paper.  Few  things  marketed  from  the  farm  can 
be  produced  in  ninety  days,  which  is  the  maximum 
maturity  for  other  paper  eligible  for  purchase  by 
Federal  Reserve  Banks.  Agricultural  and  live  stock 
paper  having  more  than  three  but  less  than  six 
months  to  run,  however,  may  be  received  for  dis- 
count by  Federal  Reserve  banks  to  an  amount  to 
be  fixed  from  time  to  time  for  each  Federal  Reserve 
bank  by  the  Federal  Reserve  Board.  The  market- 
Si 


52          LOANS   AND   INVESTMENTS 

ing  of  staples  such  as  cotton  and  wheat  is  a  diffi- 
cult problem.  The  time  they  are  ready  for  sale 
cannot  be  controlled  and  distributed  throughout 
the  year,  as  in  the  case  of  manufactured  articles,  but 
is  regulated  by  seasons  and  weather  conditions; 
and,  with  moderate  variation,  each  crop  is  ready 
in  all  sections  at  about  the  same  time.  Transporta- 
tion facilities  are  inadequate  to  move  such  vast 
quantities  immediately,  storage  room  can  not  be 
provided  at  the  various  mills  which  will  consume 
it,  and  prices  would  of  course  be  demoralized  if  the 
entire  crop  were  thrown  on  the  market  at  one  time. 
Thus  much  of  these  staples  remains  in  the  hands 
of  producers  for  a  time,  and  is  sold  gradually. 
When  properly  stored  and  otherwise  complying 
with  regulations,  such  goods  may  be  used  as  se- 
curity for  "commodity  paper,"  which  is  eligible  for 
discount  by  Federal  Reserve  banks  at  favorable 
rates. 

43.  GRAIN  CROPS.— The  leading  crops  are 
wheat,  corn,  oats  and  barley.  The  term  "grain,"  as 
used  in  banking  and  commodity  exchange  circles, 
usually  applies  to  these  four  products,  but  it  may 
be  used  to  include  flaxseed,  rye  and  buckwheat. 
About  200,000,000  acres  of  land  are  devoted  to  the 
production  of  the  country's  grain  crops.  The  prin- 
cipal wheat  growing  States  are  North  Dakota, 
Kansas,  Minnesota,  Nebraska,  Washington,  Illi- 
nois, Indiana,  Missouri,  Ohio,  South  Dakota,  Penn- 
sylvania, Montana,  Oklahoma,  Iowa  and  Oregon. 


LOANS   AND   INVESTMENTS          53 

The  country's  wheat  crop,  in  recent  years,  has 
varied  from  about  635,000,000  bushels  to  about 
900,000,000  bushels.  Over  70  per  cent,  of  the 
world's  annual  corn  crop  is  grown  in  the  United 
States.  In  recent  years  the  American  crop  has 
varied  from  2,447,000,000  bushels  to  about  3,125,- 
000,000  bushels.  The  principal  corn  producing 
States  are  Iowa,  Illinois,  Missouri,  Ohio,  Indiana, 
Kansas,  Nebraska,  Texas  and  Oklahoma.  The 
annual  oats  crop  of  the  United  States  ranges  from 
about  953,000,000  bushels  to  1,419,000,000  bushels. 
It  is  equal  to  from  20  to  30  per  cent,  of  the  world's 
crop.  The  annual  barley  crop  of  the  United  States 
varies  from  136,500,000  bushels  to  233,800,000 
bushels.  Generally  speaking,  grain  is  shipped  in 
bulk.  This  is  true  of  interior  shipments  when  made 
by  rail  or  water  carriers,  and  of  shipments  for 
export.  The  only  exceptions  are  grain  handled 
on  the  Pacific  Coast,  where  it  is  usually  packed  in 
sacks,  and  in  special  export  shipments  to  Africa 
and  Australia. 

44.  GRAIN  ELEVATORS  AND  WARE- 
HOUSES.—"Grain  elevator"  is  a  term  applied  to 
a  storage  warehouse  for  grain.  Elevators  are 
either  owned  by  grain  producers,  by  jobbers,  by 
warehouse  companies,  or  by  railroad  carriers. 
Some  elevators  are  privately  owned  and  used  by 
the  owner  for  storing  the  grain  purchased  by  him. 
Others  are  operated  as  public  warehouses.  Usually 
the  grain  of  various  owners  is  placed  in  the  same 


54          LOANS   AND    INVESTMENTS 

bin,  care  being  taken  that  all  of  grain  deposited 
in  a  particular  bin  is  of  the  same  grade  and  quality. 
Where  grain  is  thus  placed  in  elevators,  the  identity 
of  individual  lots  is  lost.  Special  arrangements 
may  be  made  in  the  case  of  public  elevators  for 
the  preservation  of  identity,  but  higher  storage 
rates  must  be  paid  under  those  circumstances. 
Country  elevators,  relatively  small  in  capacity,  are 
to  be  found  all  over  the  grain-producing  sections 
of  the  country.  They  serve  the  purpose  of  locally 
concentrating  the  crop  raised  in  each  small  district, 
before  the  same  is  shipped  to  one  of  the  central 
markets.  Each  farmer  hauls  his  grain  to  the  near- 
est elevator,  where  it  is  conveniently  weighed  and 
then  dumped  into  the  elevator.  The  owners  of 
these  country  elevators  usually  purchase  for  cash 
the  grain  delivered  by  the  farmers,  and  they  in  turn 
sell  the  accumulated  supply  to  dealers  located  in 
the  larger  centres.  There  are  four  principal 
classes  of  country  grain  elevators:  first  those 
operated  by  "line  companies" ;  second,  those  owned 
by  local  grain  dealers;  third,  those  operated  by 
farmers'  co-operative  associations  or  companies, 
and  fourth,  those  run  by  mill  owners  and  malting 
concerns.  "Line  companies"  are  corporations 
which  own  and  operate  a  chain  of  elevators  along 
one  or  more  railroad  routes,  and  which  have  head- 
quarters in  primary  markets,  to  which  shipments 
are  made  of  the  grain  bought  and  collected  from 
farmers. 


LOANS   AND    INVESTMENTS          55 

45.  MARKETING  GRAIN.  —  Owners  of 
country  elevators  pay  the  farmer  for  his  grain  as 
soon  as  it  is  weighed  and  deposited.  Owners  of 
local  country  elevators,  whether  they  be  small 
dealers  or  line  companies,  obtain  financial  assist- 
ance by  borrowing  money  from  banks  on  shipping 
documents  covering  the  grain  sent  to  primary  mar- 
kets. Money  is  also  borrowed  on  grain  stored  in 
the  elevators,  insurance  certificates  being  required. 
The  grain  which  is  not  consumed  locally  finds  its 
way,  sooner  or  later,  to  one  of  the  primary  markets, 
which  are  large  distributing  centres  for  domestic 
and  export  trade  in  wheat,  corn,  oats  and  barley. 
The  sixteen  leading  primary  grain  markets  are 
Chicago,  Minneapolis,  Kansas  City,  St.  Louis, 
Duluth,  Milwaukee,  Omaha,  Peoria,  Louisville, 
Cincinnati,  Indianapolis,  Toledo,  Cleveland,  De- 
troit, Wichita  and  Little  Rock.  The  aggregate 
receipts  of  these  markets  are  greatly  in  excess  of 
1,000,000,000  bushels  and  the  shipments  amount  to 
from  60  to  65  per  cent,  of  the  receipts.  Not  only 
are  large  supplies  of  grain  concentrated  at  these 
primary  markets,  but  facilities  are  afforded  in  these 
cities  for  cleaning,  mixing,  weighing,  grading  and 
storing  the  grain  gathered  from  the  numerous  local 
markets.  There  are  grain  exchanges  in  these 
centres,  and  many  milling  and  malting  establish- 
ments are  located  there.  The  elevator  warehouse 
facilities  are  naturally  larger  than  those  found  in 
the  smaller  cities,  and  usually  these  warehouses 


56          LOANS   AND    INVESTMENTS 

are  subject  to  inspection  and  supervision  by  State 
authorities,  or  by  the  exchange  authorities,  or  by 
both.  Elevators  located  in  the  primary  markets 
are  equipped  with  machinery  for  loading  and  un- 
loading grain  on  and  from  water  and  rail  carriers. 
Some  of  these  elevators  are  "floating"  warehouses, 
and  may  be  moved  close  to  ships  bringing  in 
grain.  They  are  also  equipped  with  hoppers,  clean- 
ing machines,  dryers,  blowers  and  scouring  plants. 
The  leading  seaboard  markets  are  New  York,  Bal- 
timore, Philadelphia,  Boston,  New  Orleans,  San 
Francisco,  Puget  Sound  points,  and  Portland,  Ore. 
Grain  is  also  exported  by  lake  through  the  Welland 
Canal  and  via  the  St.  Lawrence  river  from  Chicago, 
Duluth,  Detroit  and  other  Great  Lake  ports. 

46.  STATE  AND  FEDERAL  REGULA- 
TION.— Some  of  the  States  have  laws  governing 
the  operation  of  public  grain  elevator  warehouses. 
Many  of  the  laws  specifically  prohibit  discrimina- 
tion in  charges  and  services  and  require  licensing 
and  bonding  of  warehouse  proprietors.  Provisions 
are  also  made  for  the  issuance  of  reports  showing 
the  amount  of  grain  stored,  and  in  some  cases  it 
is  required  that  the  grain  should  be  graded  and 
weighed  and  certificates  issued  by  State  grain  in- 
spectors. The  warehousemen  are  authorized  to 
issue  negotiable  receipts  upon  which  must  be 
stated  the  quantity  and  grade  of  the  grain  stored. 
Public  elevators  in  Chicago,  for  instance,  are  also 
required  to  register  all  receipts  issued.  Under  the 


LOANS   AND    INVESTMENTS          57 

Federal  Grain  Standards  Act,  passed  in  August, 
1916,  the  Secretary  of  Agriculture  was  vested  with 
authority  to  prepare  standards  of  various  grades 
of  grain  that  may  be  traded  in.  The  law  also 
authorizes  Government  supervision  of  the  work  of 
State  inspectors  and  inspectors  engaged  by  grain 
exchanges. 

47.  GRAIN  EXCHANGES.— The  grain  ex- 
changes  operate  inspection  departments  or  bureaus, 
the  function  of  which  is  to  inspect  the  grain  stored 
in  the  terminal  elevators.  All  the  grain  which  is 
received  in  Chicago  or  New  York  is  inspected  and 
certificates  are  issued.  Exchanges  usually  publish, 
a  list  of  approved  elevators.  The  inspection  by  the 
exchanges  prevents  the  delivery  of  unmerchantable 
grain  or  of  grain  of  a  quality  inferior  to  the  one; 
called  for.  The  exchanges  establish  the  grades, 
regulate  the  mixing,  and  weigh  all  the  grain  re-* 
ceived.  Small  fees  are  charged  for  the  inspection. 
Canadian  grain  received  "in  bond"  for  trans-ship- 
ment to  foreign  ports  is  not  inspected,  but  is  only 
weighed.  Members  of  the  grain  exchanges  trans-: 
act  business  both  in  "spots"  and  in  "futures."  The 
relative  prices  at  the  different  markets  are  largely 
influenced  by  the  cost  of  transporting  the  grain, 
but  also  by  other  factors,  such  as  the  local  supply 
and  demand,  the  world's  supply  and  demand,  and 
other  considerations  governing  price  fluctuations 
in  commodities.  Dealers  in  grain,  and  the  millers 
who  produce  flour,  utilize  the  machinery  of  the 


58          LOANS   AND   INVESTMENTS 

exchange  for  "hedging"  purposes — just  as  cotton 
merchants  and  spinners  use  the  cotton  exchanges 
to  protect  themselves  against  price  movements. 

48.  GRAIN    LOANS.  — Grain  stored  on  the 
farm  may  be  covered  by  a  mortgage  and  thus 
form  the  basis  for  a  loan  by  a  country  bank.    The 
farmer  sells  his  grain  for  cash  to  a  local  buyer. 
The  buyer  usually  owns  or  leases  a  grain  elevator, 
which  he  fills  as  the  farmers  haul  in  their  products. 
He  may  have  sufficient  capital  to  carry  on  his  busi- 
ness, but  as  a  rule  borrows  some  money  from  his 
local  bank.    The  loan  may  be  made  on  his  general 
assets  or  secured  in  some  way,  but  as  the  grain  he 
buys  is  not  in  a  public  warehouse  and  is  constantly 
coming  in  and  going  out,  it  is  not  the  most  desirable 
class  of  collateral.    He  will  ship  out  about  as  rap- 
idly as  possible,  using  the  capacity  of  his  elevator 
to  take  up  the  slack  between  receipts  from  the 
farmers'  wagons  and  shipments  as  freight  cars  are 
furnished  by  the  railroads. 

49.  SALES  MADE  BY  GRAIN  BUYERS.— 
The  buyer  will  sell  mostly  to  grain  dealers  in  the 
nearest  grain  center.    Sales  will  be  made  on  con- 
tract or  on  consignment.    If  on  contract,  the  buyer 
agrees  to  furnish  a  given  quantity  of  grain  of  a 
certain  kind  and  quality  at  a  certain  price  and 
within  a  certain  time.     If  on  consignment,  the 
buyer  sends  the  cars  to  grain  dealers  who  sell 
to  the  best  advantage  on  the  open  market,  and 
account  for  the  proceeds  to  the  local  buyer,  less 


LOANS    AND    INVESTMENTS          59 

tne  commission.  In  either  case  the  grain  dealer 
finances  the  local  buyer  during  the  time  the  grain 
is  in  transit  from  the  country  elevator  to  the  city. 
Assuming  that  he  is  satisfied  as  to  the  buyer's 
character  and  financial  responsibility,  the  grain 
dealer  will  authorize  him  to  draw  a  sight  draft  on 
him,  with  shipper's  order  bill  of  lading  attached, 
for  nearly  the  full  value  of  the  car  of  grain.  The 
buyer  deposits  the  sight  draft  in  his  local  bank, 
which  may  or  may  not  charge  him  something  for 
making  the  proceeds  immediately  available,  and 
thus  enabling  him  to  pay  for  more  grain.  The 
draft  will  be  presented  to  the  grain  dealer  in  the 
city  one  day  or  several  days  before  the  car  of  grain 
arrives  by  freight.  On  the  evidence  of  the  attached 
bill  of  lading,  the  grain  dealer  pays  the  draft  on 
presentation,  and  when  the  car  arrives  adjusts  with 
the  buyer  any  difference  between  its  net  value  and 
the  amount  of  the  draft. 

50.  CREDIT  GRANTED  BY  BANKS.— It 
is  evident  that  a  grain  dealer  doing  a  large  business 
will  soon  have  a  considerable  sum  of  money  ad- 
vanced on  cars  in  transit.  He  will  probably  arrange 
with  his  bank  for  a  loan  up  to  a  certain  amount  on 
his  unsecured  note,  called  his  "open  line,"  and  for 
a  Certain  additional  amount  to  be  secured  by  bills 
of  lading  or  warehouse  receipts.  Order  bills  of 
lading  are  receipts  from  railroads  or  other  common 
carriers  covering  given  quantities  of  certain  goods 
to  be  transported  and  delivered  only  on  the  order 


60          LOANS   AND   INVESTMENTS 

of  the  shipper.  The  country  buyer  endorses  the 
bills  of  lading  before  attaching  them  to  these  drafts. 
While  lacking  some  qualities  which  would  make 
them  perfect  negotiable  instruments,  the  order  bills 
of  lading  are  so  regarded  in  practice,  and  are  read- 
ily accepted  as  collateral  to  loans  to  grain  dealers. 
Such  loans  are  nearly  always  made  payable  on 
demand,  as  the  total  amount  being  used  by  the  bor- 
rower varies  from  day  to  day.  Substitutions  of 
collateral  are  made  daily  also,  as  some  cars  arrive 
and  the  bills  of  lading  are  taken  out,  and  others 
given  the  bank  on  new  cars  in  transit.  It  is  not 
uncommon  for  a  bank  to  deliver  to  the  borrower 
on  his  trust  receipt  collateral  of  this  kind  for  which 
he  will  return  substitutes  later  in  the  day. 

51.  WAREHOUSE  RECEIPTS  AS  COL- 
LATERAL.— The  grain  dealer  may  sell  the  grain 
he  receives  to  mills  or  other  dealers  locally,  in  which 
case  he  receives  immediate  payment.  Or  he  may 
sell  to  mills  or  dealers  in  some  other  city,  in  which 
case  he  will  draw  sight  draft  with  bill  of  lading 
attached,  much  as  the  country  buyer  did  in  ship- 
ping to  him.  If  public  warehouse  facilities  permit, 
some  dealers  and  mills  will  store  grain  for  future 
sale  or  use.  While  theoretically  warehouse  receipts 
cover  particular  grain  in  certain  bins  or  tanks,  it 
is  necessary  to  move  wheat  frequently  to  prevent 
spoilage,  and  thus  different  lots  of  wheat  in  some 
places  become  mixed  with  other  lots  of  the  sam^ 
grade.  Where  delivery  of  grain  in  Exchanges  or, 


LOANS   AND    INVESTMENTS          61 

Boards  of  Trade  is  made  by  means  of  warehouse 
(elevator)  receipts,  it  is  customary  to  require  that 
bond  be  furnished  to  the  Board  of  Trade  by  elevator 
operators  and  that  weighers  for  the  Board  check 
all  grain  in  and  out,  on  whose  reports  receipts 
issued  by  the  elevator  are  registered  by  the  secre- 
tary of  the  Board.  Elevators  so  bonded  and  con- 
trolled are  called  "regular."  Warehouse  receipts 
accompanied  by  insurance  policies  are  thus  good 
collateral.  Banks  loan  on  them  freely  with  mar- 
gins of,  say,  ten  to  twenty  per  cent.  Loans  on  ele- 
vator receipts  are  more  likely  to  be  time  loans,  and 
are  frequently  sold  through  brokers  or  to  banks 
in  other  cities  who  are  seeking  investments.  This 
is  particularly  true  when  the  local  banks  are  carry- 
ing full  lines  for  the  borrower  or  are  loaned  up 
closely.  As  substitution  of  collateral  is  often  de- 
sired, it  is  a  common  arrangement  for  the  local 
bank  to  hold  the  collateral  on  notes  sold  elsewhere, 
issuing  collateral  trust  certificates  to  accompany 
properly  identified  notes.  These  certificates  show 
that  the  local  bank  holds  collateral  of  estimated 
value  sufficient  to  cover  the  loan  and  is  authorized 
to  exchange  same  to  the  borrower  for  others  of 
equal  value.  Notes  of  good  firms  so  secured  are 
desirable  investments.  Loans  on  grain  stored  in 
public  warehouses  are  classed  by  Federal  Reserve 
Banks  as  "Commodity  Paper"  and  given  a  prefer- 
ential discount  rate. 
52.  COTTON  AND  ITS  PRODUCTION.— 


62          LOANS    AND    INVESTMENTS 

The  principal  cotton-growing  States  are  Texas, 
Georgia,  Alabama,  Mississippi,  Oklahoma,  South 
Carolina,  Arkansas,  North  Carolina,  Louisiana, 
Tennessee,  Florida,  Missouri  and  Virginia.  Some 
cotton  is  also  produced  in  the  States  of  California, 
Arizona,  Kansas,  New  Mexico  and  Kentucky.  The 
planted  acreage  in  recent  years  has  totaled  from 
31,500,000  to  37,500,000  acres,  the  first  four  States 
named  contributing  about  two-thirds  of  the  aggre- 
gate. The  production  of  cotton  in  the  United 
States  during  the  past  ten  years  has  varied  from 
about  10,300,000  bales  of  500  pounds  each,  to  more 
than  16,900,000  bales.  The  yield  per  acre  averages 
from  about  187  to  194  pounds,  or  slightly  less 
than  four-tenths  of  a  bale.  The  United  States  proj 
duces  about  60  per  cent,  of  the  world's  crop  of  cot- 
ton which  is  available  for  mill  consumption.  About 
sixty  per  cent,  of  each  American  crop  is  exported, 
nearly  four-fifths  of  the  foreign  shipments  going 
to  Great  Britain,  Germany  and  France. 

53.  COTTON  RAISERS.— Cotton  is  raised  in 
the  South  either  by  the  homeowner,  to  whom  the 
plantation  belongs,  or  by  the  tenant  farmer,  who 
rents  the  cotton  field  from  the  landowner.  The 
payment  of  money  rent  is  sometimes,  but  not  gen- 
erally, practiced,  and  the  tenant  farmer  usually  ar- 
ranges to  pay  his  landlord  on  a  percentage  basis 
of  the  crop.  The  two  main  methods  are  (1)  the 
landlord  and  tenant  agree  that  the  proceeds  of  the 
crop  shall  be  divided  evenly,  the  land-owner  fur- 


LOANS  AND  INVESTMENTS         63 

nishing  the  land,  houses,  horses,  feed  and  the  tools, 
and  the  tenant  supplying  the  labor;  (2)  the  land- 
lord agrees  to  furnish  only  the  land,  in  which  case 
the  terms  provide  that  the  tenant  shall  pay  over 
to  the  landlord  only  one-quarter  of  the  net  pro- 
ceeds of  the  crop.  The  Southern  States  have 
stringent  lien  laws  which  protect  the  landlords. 
Arrangements  for  renting  cotton  farm  land  are 
usually  perfected  before  Christmas,  and  the  tenant 
assumes  occupancy  on  the  first  of  the  year.  Be- 
sides the  land,  he  is  given  possession  of  a  small 
house,  fitted  with  a  stove,  a  barn  and  pasturage. 
A  tenant  farmer  is  supposed  to  have  the  necessary 
implements  and  live  stock. 

54.  MONEY  NEEDS  FOR  PLOWING.— 
Having  possession  of  the  land,  the  tenant-farmer 
begins  plowing.  Whatever  little  money  he  may 
have  saved  up  from  the  previous  year's  cotton  crop 
is  soon  spent  for  food,  and  the  farmer  is  soon 
obliged  to  buy  on  credit.  He  opens  an  account 
with  a  local  supply  house.  The  store  may  give  him 
an  open  credit,  or  it  may  require  the  farmer  to 
give  his  note,  payable  in  the  Fall.  In  certain  cases 
the  store  insists  that  the  notes  be  secured  by  a 
chattel  mortgage  on  the  farmer's  implements. 
Frequently  the  farmer,  in  order  to  obtain  credit 
from  the  supply  house,  is  obliged  to  mortgage  his 
interest  in  the  growing  crop.  Sometimes  he  goes 
to  his  bank  and  obtains  credit  by  executing  such 
a  mortgage.  The  money  borrowed  from  the  bank 


64          LOANS   AND   INVESTMENTS 

he  uses  to  buy  for  cash  instead  of  opening  credit 
at  the  supply  house.  The  owner  of  the  supply 
store  in  the  South,  having  received  little  cash  from 
his  customers,  is  obliged  to  buy  his  goods  also  on 
credit.  The  usual  practice  is  for  him  to  either 
discount  his  note  at  the  bank,  depositing  as  col- 
lateral a  bundle  of  notes  he  had  received  from  his 
tenant-farmer  customers,  or  else  to  present  his 
own  note  to  the  wholesaler  with  the  bundle  of 
customers'  notes. 

55.  PLANTING  AND  PICKING.  —  The 
planting  of  cotton  begins  either  in  the  latter  part 
of  March  or  early  in  April.  The  plant  begins  to 
grow  in  May  or  June,  and  then  it  is  time  to  begin 
"chopping,"  that  is,  to  cut  out  the  surplus  growth, 
reducing  the  sprouted  stalks  to  a  "stand,"  remove 
the  weeds  and  clean  up  the  soil.  To  do  this  work 
the  farmer  will  hire  labor,  but  in  most  cases  he  and 
his  family  will  do  their  own  "chopping."  After 
the  "chopping"  and  until  picking  time  the  farmer 
devotes  his  efforts  to  cultivating  the  field,  and  this 
process  keeps  him  busy  during  the  months  of  July 
and  August.  In  Texas,  cotton  picking  begins  in 
the  middle  of  July,  but  in  other  parts  of  the  cotton 
belt  the  picking  season  does  not  start  until  about 
the  first  of  September.  Men,  women  and  children, 
many  of  them  colored,  are  employed  in  picking 
cotton.  They  are  mostly  piece-workers,  few  being 
paid  on  a  weekly  wage  basis.  The  cotton  farmer, 
having  waited  many  months  for  the  fruits  of  his 


LOANS   AND    INVESTMENTS          65 

labor,  uses  all  haste  to  rush  his  first  bale  to  market 
in  order  to  get  cash  for  it.  The  rush  to  market  of 
first  bales  invariably  creates  a  currency  strain,  be- 
cause the  small  country  banks  are  suddenly  called 
upon  to  pay  out  a  large  sum  of  money  in  cash.  The 
farmer  needs  the  money  to  pay  his  laborers. 

56.  GINNING   OF   COTTON.— Cotton,  as  it 
is  picked,  is  hauled  in  loose  shape  by  the  farmer 
to  the  gin,  where  the  lint  is  separated  from  the 
seed.    In  some  cases  the  owner  of  the  gin  retains 
part  of  the  ginned  cotton  as  compensation  for  his 
services,  but  in  other  cases  the  ginner  is  paid  in 
cash,  so  much  per  hundred  pounds.    After  ginning, 
the  cotton  is  put  through  the  press,  from  which 
it  comes  out  in  neatly  packed  and  strapped  bales. 

57.  MARKETING  COTTON.— After  the  cot- 
ton is  packed  in  bales  the  farmer  takes  it  to  market, 
where  he  disposes  of  it  to  "cotton  factors,"  or  to 
"cotton   buyers."    Cotton  factors   act   as   selling 
agents  for  the  farmer.     Sometimes  they  sell  the 
cotton  immediately,  sometimes  they  hold  it,  and 
sometimes  they  ship  it  to  a  central  market,  where 
better  opportunities  are  presented  for  disposing  of 
the  staple  at  advantageous  prices.    These  cotton 
factors  charge  the  farmer  for  storage,  for  trans- 
portation, for  insurance,  and  a  commission  for  their 
services.    In  recent  years  the  cotton  factorage  busi- 
ness has  become  proportionately  less  important 
than  heretofore.    Cotton  buyers  are  representatives 
of  cotton  merchants  and  cotton  exporters  whose 


66          LOANS   AND    INVESTMENTS 

principal  offices  are  located  in  the  larger  cities  in 
the  South  or  in  New  York.  Cotton  buyers  are 
stationed  in  small  towns  throughout  the  South 
where  it  is  convenient  for  the  farmers  to  bring 
their  cotton.  The  farmer  hauls  his  few  bales  to 
a  local  market  where  he  meets  the  buyer.  The 
latter  inspects  the  cotton  by  cutting  into  the  bale 
to  draw  samples,  and  then  quotes  the  price  he  is 
willing  to  pay.  The  farmer,  if  dissatisfied  with 
the  offer,  may  submit  his  cotton  to  sampling  by 
another  buyer  who  may  make  a  more  attractive 
offer. 

58.  COTTON  TICKETS.— If  buyer  and  seller 
agree  upon  a  price  the  farmer  is  handed  a  ticket 
upon  which  the  purchaser  marks  the  price  per 
pound  that  is  to  be  paid.     The  farmer  takes  his 
cotton  to  a  designated  weigher,  who  marks  on  the 
ticket  the  weight  of  each  bale.    The  cotton  buyer 
does  not  always  give  the  farmer  a  check  for  the 
cotton,  but  often  expects  him  to  take  the  "ticket" 
to  the  bank  after  it  is  properly  filled  out  by  the 
weigher.    When  the  farmer  presents  the  ticket  to 
the  local  bank,  the  bank  figures  out  the  money  due 
him,  country  banks  being  equipped  with  cotton 
tables  which  facilitate  calculating  the  value  of  each 
bale.     The  farmer  is  paid  in  cash,  or  else  he  is 
advised  to  permit  the  bank  to  put  to  his  credit 
the  proceeds  of  the  sale  of  the  cotton. 

59.  BANK  ADVANCES  MONEY  TO  COT- 
TON BUYERS.— The  cotton  buyer  arranges  with 


LOANS   AND   INVESTMENTS          67 

his  bank  that  it  should  pay  upon  presentation  of 
the  tickets,  but  at  the  same  time  the  cotton  buyer 
usually  does  not  have  the  necessary  funds  to  his 
credit  in  the  bank,  and  consequently  the  bank  is 
called  upon  to  make  advances.  The  bank  either 
permits  the  cotton  buyer  to  overdraw  his  account 
during  the  day  and  give  a  note  for  same  at  the  close 
of  day — retaining  the  cotton  tickets  as  security, 
— or  else  the  cotton  buyer  is  called  upon  to  give 
a  draft  on  the  cotton  merchant  or  exporter,  whose 
agent  he  is.  These  cotton  tickets  are  tantamount 
to  certificates  of  ownership,  and  cotton  cannot  be 
moved  without  presentation  of  the  tickets.  The 
financial  strain  in  the  South  resulting  from  the 
production  of  the  cotton  crop  begins  about  June  1st 
in  Texas  and  reaches  its  height  about  August  1st. 
The  seasonal  demand  for  money  invariably  necessi- 
tates borrowing  by  Southern  banks  from  their  cor- 
respondents in  the  East.  In  view  of  the  fact  that 
during  the  cotton  picking  season  producers  are 
in  need  of  cash  to  pay  their  help,  the  Southern 
banks  not  only  require  bank  credits  but  they  are 
obliged  to  call  upon  their  central  reserve  city  cor- 
respondents to  ship  them  currency. 

60.  COLLATERAL  FOR  BANK  LOANS.— 
The  country  banks  borrowing  in  New  York  for 
crop  purposes  usually  forward  to  their  correspond- 
ents collateral  in  the  form  of  notes,  drafts  and 
chattel  mortgages  which  have  been  received  from 
merchants  and  farmers.  The  Southern  bank 


68          LOANS   AND   INVESTMENTS 

usually  executes  its  note  and  sends  the  collateral 
in  a  large  bundle.  The  New  York  bank  examines 
the  same,  but  hardly  ever  has  occasion  to  touch 
it,  inasmuch  as  the  Southern  bank  is  always  ready 
to  take  up  its  note  at  maturity.  In  the  event  that 
it  is  not  in  position  to  do  so,  the  New  York  institu- 
tion will  agree  to  a  renewal  of  the  note  for  another 
month  or  two.  Money  borrowed  by  Southern 
banks  in  August  and  September  is  usually  paid 
by  the  end  of  November. 

61.  LOANS  ON  COTTON  IN  WARE- 
HOUSES. —  While  the  cotton  buyers  purchase 
cotton  from  the  farmers  as  soon  as  the  cotton  is 
ginned  and  baled,  they  are  not  in  a  position  to 
dispose  of  the  staple  until  they  accumulate  a  sub- 
stantial shipment.  Consequently,  pending  the  de- 
livery of  cotton  to  American  mills  and  to  foreign 
spinners,  the  cotton  merchant  (for  whom  the  buyer 
has  been  acting)  is  obliged  to  place  his  cotton  in 
storage  in  warehouses,  cotton  yards  and  on  com- 
press platforms.  Requiring  funds  to  carry  the  same, 
or  to  buy  more  cotton,  the  merchant  obtains  a  loan 
from  his  bank,  secured  by  a  warehouse  receipt. 
Bankers  who  are  asked  to  advance  money  on  ware- 
house receipts  for  cotton  do  not  only  take  into  con- 
sideration the  character  and  responsibility  of  the 
borrower  but  they  examine  into  the  safety  of  the 
warehouse  and  the  financial  standing  of  the  ware- 
houseman. Warehouses,  in  issuing  receipts,  usually 
inspect  the  cotton,  weigh  the  bales  and  furnish  a 


LOANS   AND   INVESTMENTS          69 

receipt  describing  the  quantity  and  quality  of  the 
cotton  placed  in  their  care.  Congress  passed  a  bill 
in  August,  1916,  which  provides  for  the  Federal 
licensing  and  supervision  of  warehouses  where 
agricultural  products,  such  as  cotton  and  grain, 
are  stored.  It  is  believed  that  banks  will  now  be 
willing  to  advance  money  on  warehouse  receipts 
more  freely  than  they  have  been  in  the  past. 

62.  ASSISTANCE  OF  FEDERAL  RESERVE 
BANKS. — Notes  and  drafts  secured  by  approved 
warehouse  receipts  for  cotton  are  rediscountable 
at  the  Federal  Reserve  banks.  A  special  rate  for 
this  character  of  paper,  lower  than  the  trade  ac- 
ceptance rate  for  the  same  maturity,  has  been 
established  by  the  Reserve  banks  in  the  South  with 
the  approval  of  the  Federal  Reserve  Board.  This 
special  "commodity  rate"  applies  to  paper  not 
having  more  than  90  days  to  run.  The  assistance 
rendered  by  the  Reserve  banks  has  made  it  possible 
for  banks  in  the  South  to  charge  lower  rates  to 
customers  who  elect  to  carry  cotton  in  warehouses 
pending  the  receipt  of  orders  for  the  same,  or  in 
the  hope  of  obtaining  higher  prices  for  the  staple 
at  a  later  date.  By  being  able  to  rediscount  paper 
secured  by  warehouse  receipts,  the  banks  have  been 
placed  in  a  position  where  they  have  a  larger  supply 
of  funds  available  to  borrowers.  In  recent  years  it 
has  been  customary  for  the  Secretary  of  the  Treas- 
ury to  make  deposits  of  Government  funds  with 
Southern  banks  during  the  crop-moving  seasons. 


70          LOANS   AND    INVESTMENTS 

This  has  had  the  effect  of  instilling  confidence  in 
growers  and  merchants,  and  has  helped  in  prevent- 
ing or  abating  money  stringencies.  Since  Decem- 
ber 31,  1915,  instead  of  depositing  Government 
funds  with  National  banks,  the  Secretary  of  the 
Treasury  has  made  deposits  with  the  Federal  Re- 
serve banks  in  the  South. 

63.  COTTON     MERCHANTS     AND     EX- 
PORTERS.  —  Concerns  which  buy  cotton  from 
farmers  and  factors  are  known  as  "spot  houses." 
They  deal  in  all  grades  of  cotton  and  sell  to  do- 
mestic as  well  as  foreign  spinners.    Many  of  these 
houses  maintain  offices  or  headquarters  in  New 
York  and  some  operate  from  New  Orleans,  Dal- 
las,   Galveston,  Memphis  and  other  cities  in  the 
South.     The   price    offered   the   farmer   by   the 
buyer  who  examines  the  cotton  largely  depends 
upon  the  quality  of  the  cotton.    The  merchant  or 
exporter  is  very  much  concerned  with  the  grade 
and  length  of  cotton,  for  the  reason  that  spinners, 
in  making  purchases,  usually  specify  in  detail  the 
character  of  cotton  they  require.    One  grade  may 
be  available  for  one  mill  and  be  practically  of  no 
value  to  another. 

64.  CLASSIFYING  COTTON.— The  work  of 
grading  or  classifying  cotton  is  a  specialty.    Ex- 
perts are  not  common.    In  many  instances  a  single 
bale  of  cotton  will  contain  several  grades,  but  as» 
a  rule  some  one  particular  grade  is  found  in  pre-» 
ponderance.    Moreover,  cotton  varies  according  to 


LOANS   AND   INVESTMENTS          71 

the  place  of  production,  and  it  is  the  function  of 
the  spot  dealer  to  be  familiar  with  all  grades  and 
markets,  and  to  be  able  to  supply  the  exact  grade 
required  by  particular  customers.  When  a  spot 
house  receives  an  order  for  100  or  1,000  bales  of  ai 
particular  grade,  it  must  gather  the  necessary 
quantity  together  from  all  parts  of  the  South  if  it- 
finds  that  it  has  not  the  required  cotton  in  its  store 
or  warehouse. 

65.  FINANCING  EXPORTS  OF  COTTON. 
— When  the  cotton  exporter  in  the  South  receives 
an  order  to  ship  1,000  bales  to  Liverpool  at  a  fixed 
price,  he  delivers  the  cotton  to  a  railroad  or  to  an 
ocean  carrier,  if  he  happens  to  be  located  at  a  sea- 
port, and  secures  a  through  bill  of  lading.  The 
price  determined  upon  is  usually  what  is  known  as 
"C.  I.  F.  &  6%,"  i.  e.,  cost,  insurance  and  freight, 
and  6  per  cent,  for  tare  deducted.  The  shipper  has 
the  cotton  insured.  He  draws  a  60  or  90  day  draft, 
payable  to  himself,  for  the  invoice  value  of  the 
cotton.  This  he  indorses  on  the  back  in  blank. 
The  draft  or  bill  of  exchange  is  drawn  either  upon 
the  foreign  cotton  merchant  or  spinner  to  whom  the 
cotton  is  being  shipped  or  upon  a  foreign  banfe 
which  has  an  arrangement  with  the  purchaser  to 
accept  his  bills.  The  Southern  cotton  shipper  sells 
the  draft  with  the  attached  bills  of  lading  and  in- 
surance certificate  to  his  bank,  or  sends  the  draft 
with  the  documents  to  a  broker  in  New  York,  who 
sells  the  draft  to  some  New  York  institution.  The 


72          LOANS   AND   INVESTMENTS 

shipper  must  pay  a  small  commission  to  the  bank 
and  a  commission  to  the  broker.  The  bank  buying 
the  draft  pays  for  it  in  dollars,  according  to  current 
rates  of  exchange,  the  equivalent  of  whatever 
foreign  money  the  draft  may  call  for.  The  bank 
buying  the  bill  forwards  it  to  a  correspondent 
abroad,  who  presents  it  for  the  purposes  of  "ac- 
ceptance" to  the  purchaser  of  the  cotton  or  to  the 
latter's  bank.  After  the  bank  stamps  its  acceptance 
upon  the  bill  the  same  is  sold  and  bought  in  the 
open  market  until  maturity,  when  it  is  paid. 

66.  COTTON  EXCHANGES.— In  the  United 
States  there  are  only  two  markets  for  "cotton 
futures,"  one  in  New  York  and  the  other  in  New 
Orleans.  Members  of  the  cotton  exchanges  lo- 
cated in  these  two  cities  deal  in  contracts  for  the 
future  delivery  of  cotton.  The  contract  traded  in 
is  a  basic  one,  that  is,  it  provides  for  the  delivery! 
of  cotton  of  a  basic  grade,  middling,  and  provision 
is  made  for  adjustments  in  cases  where  the  cotton 
actually  tendered  for  delivery  is  not  of  the  basic 
grade  but  consists  of  a  number  of  bales  of  a  higher 
grade  and  a  number  of  bales  of  a  lower  grade* 
Under  the  form  of  contract  traded  in,  the  seller  has 
the  option  to  deliver  any  of  the  established  grades, 
price  adjustments  being  made  for  differences  in 
grades  in  accordance  with  relative  prices  for  the 
various  grades  established  by  the  "fixed  differences" 
of  the  exchange.  The  functions  of  the  exchanges 
are  to  provide  a  continuous  market,  to  disseminate 


LOANS   AND   INVESTMENTS          73 

trade  and  crop  information,  and  to  afford  an  organ- 
ization where  future  conditions  and  events  may 
be  systematically  discounted,  all  of  which  tend  to 
establish  world  prices  for  the  commodity.  More- 
over, the  exchanges  are  used  for  speculation.  Ac- 
tivity along  those  lines  helps  to  establish  a  proper, 
price  level  and  incidentally  aid  in  distributing  the; 
money  losses  and  profits  involved  in  assuming  the 
inevitable  economic  risks  of  changes  in  value. 

67.  PROCESS  OF  HEDGING.— Besides  fur- 
nishing means  for  establishing  market  prices,  one 
of  the  chief  services  rendered  by  cotton  exchanges 
is  that  of  providing  the  necessary  machinery  for 
hedging.  Hedging  is  in  the  nature  of  insurance  or 
protection  against  loss  occasioned  by  price  fluctua- 
tions. The  hedging  practice  is  resorted  to  by  cotton 
merchants,  by  spinners  and  by  manufacturers  of 
cotton  goods.  A  Southern  cotton  merchant,  con- 
tracting in  July  to  deliver  1,000  bales  of  cotton  to 
a  spinner  in  January,  will  frequently  instruct  his 
broker  on  one  of  the  exchanges  to  buy  for  him  a 
"future  contract"  for  the  same  quantity  of  cotton 
deliverable  in  January.  If  by  the  time  the  merchant 
delivers  the  cotton  to  the  spinner  the  price  has 
advanced  two  cents  a  pound  above  that  at  which  the 
contract  was  made,  the  merchant  stands  to  lose  two 
cents  a  pound.  He,  therefore,  instructs  his  broker 
to  sell  out  his  "futures"  on  the  exchange.  Inas- 
much as  the  price  of  "futures"  and  the  price  of 
"spots"  usually  fluctuate  in  unison,  it  is  safe  to 


74          LOANS   AND   INVESTMENTS 

assume  that  the  loss  the  merchant  suffered  in  the 
one  transaction  he  will  have  wholly  or  partially 
recouped  by  the  profit  on  the  other.  The  prices 
paid  to  growers  and  the  prices  at  which  cotton  is 
sold  to  domestic  and  foreign  spinners  are  based 
largely  upon  the  price  of  futures  quoted  on  the 
exchanges. 

68.  UNITED  STATES  COTTON  FUTURES 
ACT.— As  amended  by  the  Act  of  August  11,  1916, 
the  United  States  Cotton  Futures  Act  of  February 
18,  1915,  provides  for  Government  regulation  of 
trading  in  contracts  for  the  future  delivery  of  cot- 
ton.   Briefly,  it  imposes  certain  requirements  for 
the  conduct  of  business  on  the  cotton  exchanges, 
and  imposes  a  penal  tax  of  two  cents  per  pound 
in  the  event  that  transactions  are  not  carried  on  in 
accordance  with  the  specifications.    The  law  vests 
with  the  Secretary  of  Agriculture  authority  to  pre- 
pare and  promulgate  standard  grades  of  cotton. 
The  law  also  makes  provision  for  the  settlement 
by  the  Agricultural  Department  of  disputes  arising 
between  buyer  and  seller.    The  amendment  to  the 
act  provides  for  trading  in  specific  contracts. 

69.  LIVE  STOCK  LOANS.— Live  stock  rais- 
ing is  one  of  the  most  important  factors  in  the 
economic  life  of  our  nation.    Horses  and  mules  as 
work  animals  are  almost  indispensable  to  agricul- 
ture; sheep  and  hogs  produce  great  wealth  in  meat, 
wool,  lard,  etc. ;  but  cattle  are  the  greatest  source 
of  income,  giving  us  beef  for  ourselves  and  for 


LOANS   AND   INVESTMENTS          75 

export,  hides  for  leather,  milk,  butter,  cheese  and 
the  innumerable  by-products  of  packing  houses 
which  increase  returns  so  largely.  They  are  the 
basis  for  many  loans  and  of  great  interest  to  bank- 
ers. Farmers  are  realizing  more  keenly  and  more 
generally  than  ever  that  the  best  way  to  market 
corn,  hay  and  other  feedstuffs,  is  on  the  hoof,  or  as 
dairy  products,  and  that  by  so  doing  they  not  only 
obtain  the  greatest  return  for  their  salable  crops, 
and  use  some  which  would  otherwise  be  worthless, 
but  they  can  return  to  the  soil  much  of  its  fertility. 
Cattle  are  raised  in  every  State  in  the  Union,  both 
for  beef  and  for  dairy  purposes.  It  is  claimed  that 
no  breed  of  cattle  combines  satisfactorily  milk  and 
beef  qualities,  and  for  convenience  we  will  consider 
them  divided  into  these  two  classes. 

70.  DAIRY  CATTLE.— Scientific  dairying  is 
highly  developed  in  Wisconsin,  Minnesota,  Ohio, 
Pennsylvania,  New  York,  Iowa  and  certain  other 
States,  where  it  has  been  carried  on  successfully 
for  many  years,  and  herds  of  registered  and  other 
high  grade  cattle  are  the  rule.  The  income  from 
animals  of  this  type  can  be  anticipated  with  reason- 
able certainty.  Loans  to  owners  are  commonly 
made  on  their  showing  of  assets,  including  cattle, 
and  not  on  chattel  mortgage  security.  Such  loans 
to  experienced  and  responsible  men  are  most  de- 
sirable. Dairying  is  a  growing  industry  in  many 
States  in  addition  to  those  named.  The  rapid 
increase  of  population  m  cities,  and  the  stronger 


76          LOANS   AND   INVESTMENTS 

demand  universally  for  milk  and  milk  products  of 
high  sanitary  standard,  have  made  it  increasingly 
profitable.  The  establishment  of  creameries  and 
condensaries  has  helped  greatly.  In  some  sections, 
such  as  Kansas  and  Oklahoma,  bankers  have 
brought  in  good  young  cows  from  well-known  dairy 
herds  and  sold  them,  one  or  two  or  three  to  a  man, 
lending  him  the  whole  amount  of  the  purchase  price 
with  a  mortgage  on  the  cows  as  security.  When 
care  is  used  in  selecting  the  men  with  whom  this 
arrangement  is  made,  it  soon  results  in  a  profit  to 
both  banker  and  farmer,  and,  better  still,  helps  in 
the  upbuilding  of  the  community  from  which  the 
bank  draws  its  support.  In  new  countries  the  wife's 
few  cows  (with  the  help  of  the  chickens)  have  often 
brought  in  the  only  cash  income  the  family  had 
while  they  established  themselves  and  raised  a  crop. 
Agriculture  received  the  man's  thought  and  effort 
for  a  few  years  because  it  required  less  capital  and 
brought  quicker  returns  than  livestock  raising. 
When  his  finances  permitted  he  branched  out  into 
fattening  some  cattle  on  his  grain  and  thus  making 
two  profits.  Dairying  came  much  later  on,  when 
the  price  of  milk  advanced,  its  marketing  became 
convenient  and  the  continuous  income  offered  at- 
tractions. So  all  through  the  farming  section  of 
the  central  plains  States  will  be  found  these  stages 
of  evolution;  not  that  dairying  crowds  out  feeding, 
but  it  finds  its  own  place,  stays,  and  adds  to  the 
growing  wealth  of  our  nation.  Bankers  may  sus- 


LOANS   AND    INVESTMENTS          77 

tain  losses  on  loans  for  pretentious  attempts  in 
dairying  by  inexperienced  men  with  high-priced 
cattle,  but  loans  of  moderate  amounts  to  capable 
and  industrious  men  for  the  purchase  of  dairy  cows 
are  thoroughly  sound. 

71.  BEEF  CATTLE.  — The  raising  of  cattle 
for  beef  purposes  is  likewise  a  science.  It  must  be 
remembered  that  while  a  great  many  animals  in 
the  aggregate  remain  in  the  hands  of  their  first 
owners  until  sold  for  slaughter  in  a  local  abbattoir, 
others  are  sold  half  a  dozen  times  and  are  shipped 
to  and  from  market  three  or  four  times  before  killed. 
These  markets  are  the  stockyards  where  packing 
houses  are  located.  The  large  packing  houses  will 
buy  at  all  times  cattle  of  any  age  or  weight,  whether 
young  calves  for  veal  or  old  ("canner")  cows  and 
("bologna")  bulls.  The  prices  offered  fluctuate 
constantly,  but  a  man  who  wants  to  sell  is  sure 
when  he  ships  cattle  to  the  stockyards  that  he  will 
find  a  buyer.  Nor  are  the  packing  houses  the  only 
buyers  at  the  stockyards.  A  farmer  or  cattle  man 
who  wants  a  certain  number  of  a  certain  kind  of 
cattle  goes  in  person  or  instructs  a  commission  firm 
in  whom  he  has  confidence  to  buy  them  for  him 
on  the  market.  It  not  infrequently  happens  thaU 
he  will  buy  and  ship  back  home  cattle  which  were 
sent  in  from  his  own  neighborhood.  One  man  may 
bring  in  steers  which  he  thinks  are  thoroughly  fat. 
Another  man  sees  them  and  believes  that  by 
judicious  feeding  he  can  put  more  weight  on  them 


78          LOANS   AND   INVESTMENTS 

in  a  short  time,  and  profit  by  a  fancier  price  as 
well  as  the  added  number  of  pounds.  There  are 
speculators  there,  too,  ready  to  buy  nearly  any- 
thing on  which  they  have  a  chance  to  make  money. 
Scattered  animals  of  quality  unlike  others  in  the 
same  lot,  when  brought  into  a  bunch  similar  to 
themselves,  sell  to  better  advantage.  Shipments 
received  late  in  the  day  may  sometimes  be  bought 
cheap  enough  to  pay  to  carry  them  over  night  and 
leave  the  speculator  a  profit.  The  market  price 
is  affected  by  the  number  of  cattle  offered  for  sale. 
This  in  turn  is  affected  by  the  time  of  year  and 
by  the  season's  weather  conditions.  Drought  re- 
sulting in  lack  of  stock  water,  dried  up  pastures, 
and  short  feed  crops,  will  send  cattle  to  market; 
a  favorable  season  will  keep  them  away  longer. 
Conditions  which  are  only  local  do  not  make 
much  difference  in  the  price,  as  the  market  re- 
flects the  average  for  the  whole  tributary  terri- 
tory, but  the  general  crop  situation  has  quite  an 
influence.  Cattle  have  gradually  gone  higher  in 
price  for  several  years.  Meanwhile  most  of  the 
largest  ranches  have  been  broken  up,  some  into 
smaller  pastures,  some  partly  put  to  agricultural 
purposes.  The  class  of  cattle,  notably  in  Texas, 
has  improved  so  greatly  as  to  fully  equal  those  in 
older  States.  Farther  north  the  agricultural  col- 
leges have  taught  that  balanced  rations  will  reduce 
the  time  and  cost  for  fattening.  It  must  be  con- 
sidered that  in  every  step  of  handling  cattle,  breed- 


LOANS   AND    INVESTMENTS          79 

ing,  raising,  fattening,  marketing,  there  is  constant 
change,  and  that  no  rules  except  of  the  most  general 
nature  can  be  laid  down  as  to  the  practice  of  loan- 
ing money  on  them.  It  takes  about  four  years  to 
produce  a  beef  animal;  and  while  there  is  a  market 
for  it  all  the  time,  to  sell  too  soon  or  to  hold  too 
long  means  a  loss  to  its  owner.  Money  can  be 
loaned  for  only  a  few  months  at  a  time  to  complete 
some  one  of  the  processes  in  its  production. 

72.  DEVELOPMENT  OF  THE  INDUS- 
TRY.—  It  has  not  been  many  years  since  the 
buffalo  roamed  the  plains  of  Nebraska,  Kansas, 
Oklahoma,  Texas,  New  Mexico  and  parts  of  Col- 
orado, Wyoming  and  Montana.  It  was  an  ideal 
place  for  stock  raising  and  was  soon  put  to  that 
use  by  the  white  man.  The  public  land  was  leased 
for  almost  nothing,  or  used,  as  it  frequently  was, 
without  making  any  payment  at  all.  Gradually 
much  of  it  passed  into  the  hands  of  a  relatively 
small  number  of  men,  each  of  whom  controlled 
many  thousands  of  acres.  There  were  no  fences, 
and  for  purposes  of  identification  each  owner  had 
his  mark  or  "brand,"  which  was  burned  into  the 
hide  of  each  animal  with  a  hot  iron.  Effective  as 
this  method  is,  it  did  not  satisfy  the  New  York 
money  lender  of  a  generation  ago,  who  is  reputed 
to  have  said  "I  would  just  as  soon  have  a  mortgage 
on  a  school  of  herring  in  the  Atlantic  Ocean  as  on 
a  herd  of  cattle  in  Texas."  The  breeding  grounds 
of  the  buffalo  were  mostly  in  the  warm  climate 


80          LOANS   AND   INVESTMENTS 

of  the  South  and  Southwest  and  in  the  spring  of 
the  year  a  migration  set  in  northward  with  the 
growth  of  the  grass.  So  with  the  cattle.  They 
were  bred  in  the  South  and  Southwest  and  grad- 
ually drifted  north  toward  the  markets  through 
the  range  country  as  spring  and  summer  advanced. 
When  the  free  ranges  were  finally  fenced  into  huge 
ranches,  the  handling  of  cattle  continued  much  as 
before,  except  that  where  conditions  were  not 
favorable  to  the  breeding  of  cattle  but  were  better 
adapted  to  the  feeding  and  completion  of  them, 
cattle  were  shipped  in  from  the  great  southern 
breeding  grounds.  As  the  larger  ranches  were 
divided  into  smaller  ones,  specialization  became  a 
little  more  advanced,  so  that  shipments  and  changes 
in  ownership  were  more  frequent.  With  the  influx 
of  population  that  required  and  demanded  land 
for  farming  purposes,  there  was  a  conversion  into 
farms  of  those  ranches  which  appeared  adapted 
to  the  purpose.  These  first  farmers  were  not  cattle 
raisers.  It  seemed  foolish  to  compete  with  men 
producing  cattle  so  cheaply  on  the  ranches.  Many 
failed  to  farm  successfully  because  of  ignorance  of 
the  soil,  climatic  conditions,  and  related  natural 
laws  which  must  be  followed.  Gradually  this 
knowledge  was  acquired  and  corn  and  other  feed 
became  plentiful.  Cattle  prices  were  advancing 
and  it  was  seen  to  be  profitable  to  put  a  bunch  of 
them  in  the  feed  lot  for  fattening  in  the  fall  and 
sell  them  in  the  spring.  Thus  the  territory  be- 


LOANS   AND    INVESTMENTS          81 

came  divided  roughly  into  sections  corresponding 
with  the  steps  in  the  production  of  the  beef  animal. 
73.  QUARANTINE  LINE.  —  Bred  in  the 
South,  the  animals  remain  there  until  about  a 
year  old,  then  they  are  moved  north  into  Texas 
and  Oklahoma  and  some  counties  in  Kansas  and 
Colorado,  where  the  winters  are  a  little  more 
severe,  and  when  three  to  four  years  old  they 
are  taken  into  the  feeding  sections  of  Kansas, 
Missouri,  Nebraska,  Iowa,  Illinois,  etc.  In  this 
movement  northward  the  quarantine  line  is 
crossed,  where  each  animal  must  be  "dipped"  to 
prevent  carrying  fever  contagion  to  uninfected 
districts,  or  else  shipped  direct  to  separate  "quar- 
antine" pens  at  the  stockyards  for  killing.  The 
purchaser  in  each  northward  movement  may  go 
south  and  search  for  such  a  bunch  of  cattle  as  he 
wants,  or  he  may  go  to  a  central  market  where 
there  are  many  sellers.  Cattle  will  be  owned  on  the 
average  by  four  stockmen  before  sold  for  killing. 
On  any  of  the  trips  to  market  the  packer's  offer 
may  be  higher  than  that  of  any  feeder,  and  the 
cattle  go  for  beef.  Some  of  the  calves  will  be  taken 
when  still  carrying  the  milk  fat,  and  fed  so  as  to 
retain  this,  and  reach  a  size  and  weight  at  about  a 
year  old  that  enable  them  to  be  sold  for  "baby  beef." 
Thus  the  variations  from  the  schedule  given  above 
are  numerous,  and  while  it  persists  in  the  main  it 
is  quite  irregular.  The  plateaus  and  valleys  of  the 
Rocky  Mountain  and  Pacific  Coast  States  produce 


82          LOANS    AND    INVESTMENTS 

conditions  quite  similar  to  those  in  the  Western 
Plains  States. 

74.  LOANS    ON    RANCH    CATTLE.— It  is 
evident  that  since  ranch  cattle  are  handled  in  rather 
large  herds  the  funds  of  small  local  banks  are  en- 
tirely inadequate  to  carry  the  necessary  loans.  This 
want  was  at  one  time  largely  met  by  commission 
firms  at  the  markets,  who  made  loans  to  buyers 
of  cattle  through  them,  endorsed  the  notes  and 
sold  them  wherever  they  could  find  buyers.     As 
the  paper  came  to  be  in  demand,  the  firm  found^ 
it  possible  to  make  a  brokerage  on  the  loans  and 
commissions  on  the  purchase  and  sale  of  the  cattle- 
Desire  to  do  a  large  volume  of  business  and  some 
unfavorable  seasons  resulted  in  failure  on  the  part 
of   some    firms   to   protect   endorsed   paper   and 
brought  these  loans  into  disrepute.    There  are  good 
firms  doing  a  conservative  and  profitable  business 
now  in  both  commission  and  brokerage  lines,  but 
in  late  years  the  tendency  has  been  to  make  them 
separate  businesses.     Live  stock  loan  companies 
have  been  incorporated  with  organizations  equipped 
to  inspect  the  cattle  mortgaged  and  all  conditions 
which  influence  the  success  of  the  undertaking. 

75.  STOCKER    LOANS.  —  A  loan  on  aged 
steers  to  finance  their  final  fattening  is  about  as 
certain  of  natural  liquidation  at  maturity  as  can 
be  found.    Younger  steers  are  practically  always 
in  demand  in  some  parts  of  the  country  and  are 
hardier  than  cows.    Hence  natural  division  of  cattle 


LOANS  AND   INVESTMENTS          83 

loans  is  into  (1)  those  on  steers  one  year  or  more 
old  and  (2)  those  on  stock  cattle,  consisting  of 
breeding  cows,  heifers,  calves  and  bulls.  Loans  on 
stock  cattle,  when  made  to  reliable  and  capable 
men,  are  about  as  certain  of  ultimate  payment  as 
any  othess,  but  it  is  not  so  certain  that  payment 
can  be  forced  at  maturity  without  inconvenience 
and  possible  loss  to  the  borrower.  Unfavorable 
seasons,  unusual  death  losses  among  the  calves,  a 
bad  market,  etc.,  may  leave  the  deal  without  profit, 
or  worse,  if  immediate  sale  must  be  made;  but  by 
selling  some,  and  perhaps  extending  the  time  an- 
other six  months  or  a  year,  to  increase  the  calf 
profit,  the  deal  may  eventually  turn  out  very  well. 
Local  banks  may  well  make  loans  of  this  kind,  as 
they  know  the  customers  thoroughly,  are  on  the 
ground  all  the  time,  and  can  step  in  and  take  the 
cattle  if  necessary  before  a  serious  loss  occurs. 
Such  loans,  with  local  bank  endorsements,  are 
readily  taken  by  bank  correspondents  to  an  extent 
based  largely  on  their  balances.  The  steer  loans 
can  be  obtained  from  larger  banks  or  from  cattle 
loan  companies.  The  loan  companies,  however,  do 
make  loans  on  stock  cattle  very  frequently,  and 
when  there  is  a  surplus  of  money  and  the  demand 
for  paper  is  great,  buyers  take  the  notes  readily. 
On  the  whole,  "cow  loans"  are  not  quite  so  good 
for  the  distant  purchaser  and  should  be  kept  as 
close  at  home  as  possible. 
76.  STEER  LOANS.— The  largest  part  of  the 


84          LOANS   AND   INVESTMENTS 

paper  sold  by  the  loan  companies  is  secured  by 
steers.     Without  forgetting  that  loans  on  other 
classes  of  cattle  are  handled  similarly,  a  steer  loan 
may  be  considered  as  typical.    In  April  or  May  a 
cattleman  of  experience  goes  to  the  loan  company 
where  he  is  acquainted  and  tells  them  he  wants  to 
borrow  thirty  thousand  dollars  to  buy  two-year-old 
steers,  for  which  he  has  sufficient  pasture  with  good 
water  to  carry  them  until  fall.    If  he  has  cash  on 
hand  for  part  of  the  cost  price,  so  much  the  better, 
but  a  considerable  margin  will  not  be  required,  and 
sometimes  the  whole  purchase  price  will  be  loaned. 
This  is  because  the  lender  looks  at  some  other 
things  in  addition  to  the  property  to  be  mortgaged* 
The  man  himself  is  the  first  consideration;    his 
record  as  a  successful  handler  of  cattle,  and  his 
reputation  for  honesty  and  industry.    There  is  a 
saying  that  "the  brand  on  the  man  is  more  im- 
portant than  the  brand  on  the  steer."    The  second 
question  is,  are  the  cattle  worth  the  money,  and  of 
such  a  class  as  will  increase  in  value  through 
natural  growth  and  reasonably  insure  payment  of 
the  debt  when  due?    Third,  has  he  made  ample 
provision  for  taking  care  of  the  steers  during  the 
life  of  the  loan?    Fourth,  what  other  assets  has  the 
borrower?    As  a  matter  of  record  and  to  set  these 
points  out  in  detail  for  consideration,  a  statement 
will  usually  be  asked  for.    Items  to  be  found  in 
such  statements  include  name,  age,  legal  residence, 
with  Section,  Township,  Range,  County,  State  and 


3        LOANS   AND   INVESTMENTS          85 

Post  Office;  under  assets,  the  personal  property, 
giving  number  of  steers  one  year  old,  steers  two 
years  old,  steers  three  years  old,  steers  four  years 
old  and  over,  heifers  one  and  two  years  old,  cows, 
calves  (with  year  of  birth),  bulls,  horses,  mules, 
sheep,  and  hogs,  the  per  head  and  total  value  ofi 
each  class  being  shown,  feed  on  hand  (itemized), 
cash  on  hand,  and  other  personal  property,  and  also 
real  estate,  including  homestead  less  exemption 
and  other  real  estate  less  encumbrance;  under 
liabilities,  full  details  of  any  encumbrance  on  live 
stock,  other  borrowed  money,  amount  due  relatives 
and  other  debts;  under  general  information,  the 
number  of  acres  and  kind  of  land  under  lease,  the 
rental  price,  statement  as  to  any  judgments  or  suits 
pending,  reference  to  other  persons  informed  as 
to  borrower's  financial  condition,  number  of  years 
lived  at  present  location,  former  residence,  whether 
surety  on  anv  notes  or  bonds,  etc. 

77.  PURCHASE  AND  DELIVERY.  —  The 
application  having  been  considered  favorably,  the 
cattleman  arranges  his  purchase.  The  delivery  of 
the  cattle  to  him,  payment  therefor  to  the  seller, 
inspection  of  the  cattle  by  the  agent  for  the  loan 
company,  execution  and  delivery  of  the  note  and 
mortgage,  and  filing  of  same  for  record  in  the  proper 
place  or  places,  will  be  as  nearly  simultaneous  as 
possible.  In  this  instance  the  loan  company  takes 
six  notes  of  five  thousand  dollars  each,  all  secured 
by  the  one  mortgage.  This  is  so  that  one  or  more 


86          LOANS   AND   INVESTMENTS 

of  the  notes  may  be  sold  to  customers  who  could 
not  carry  as  much  as  thirty  thousand  dollars  of  any 
one  maker's  paper.  These  are  called  "split  loans." 
A  few  bankers  will  not  buy  notes  unless  all  of  the 
loan  is  owned  by  them,  as  they  believe  there  is  a 
possibility  of  loss  due  to  the  diverse  interests,  if 
anything  goes  wrong,  and  quick  action  to  a  single 
purpose  is  necessary.  Other  buyers  rely  on  the 
loan  company's  endorsement  and  accept  "split 
loans"  without  question.  Banks  and  others  seek- 
ing investments  write  to  the  loan  company  for 
paper.  The  notes  are  sold  them,  endorsed  by  the 
loan  company,  at  a  lower  interest  rate  than  the 
company  charged  the  borrower.  Copies  of  the 
mortgage  and  of  the  maker's  statement  may  or  may 
not  accompany  each  note.  The  loans  run  about 
six  months,  being  chiefly  made  in  April  or  May  and 
September  or  October.  This  is  partly  because 
banks  are  unwilling  to  put  their  money  out  for 
longer  periods,  and  partly  because  these  are  the 
seasons  of  change  in  cattle  ownership,  when  one 
man  takes  his  profit  to  date  and  another  begins  the 
next  process  in  the  growing  of  the  animal.  When 
the  notes  come  due  the  loan  company  must  provide 
for  their  prompt  payment  to  the  holders,  and  this 
whether  the  cattle  are  sold  and  money  paid  by  the 
borrower  or  not.  It  must  be  prepared  to  carry 
some  paper  for  a  short  time  with  its  own  funds. 
The  company  will  have  kept  track  of  the  cattle 
during  the  six  months,  watching  for  any  unfavor* 


LOANS   AND    INVESTMENTS          87 

able  condition  or  any  dishonesty,  and  will  know 
when  they  can  be  sold.  If  the  borrower  wants  to 
keep  them  six  months  longer,  the  company  may 
consent,  and  so  make  a  new  loan  on  the  same  cattle 
to  the  same  man.  Otherwise  they  are  put  on  the 
market  and  enough  of  the  proceeds  turned  over  to 
the  loan  company  to  satisfy  its  claim.  If  the  pro- 
ceeds should  be  insufficient,  the  borrower  must 
make  up  the  difference  in  some  other  way  or  the 
company  loses. 

78.  FEEDER  LOANS.— The  paragraphs  just 
preceding  refer  to  cattle  in  pastures  where  grass 
is  practically  the  only  food  they  have  except  per- 
haps some  cotton  seed  cake  in  bad  weather.  Men- 
tion has  been  made  of  cattle  going  to  the  feed  lots 
of  Kansas,  Iowa,  Illinois,  etc.,  when  they  have  about 
reached  maturity,  to  be  fattened  for  killing.  In 
addition  to  the  Southern  bred  cattle  brought  in, 
there  are,  of  course,  many  which  have  been  raised 
in  small  bunches  in  these  central  States.  Often 
superior  individual  attention  and  careful  feeding 
matures  them  at  an  earlier  age  than  the  Texas 
steer.  Wherever  they  have  been  raised,  they  may 
be  fattened  in  pastures  on  grass  in  the  spring  and 
summer,  but  those  to  be  fattened  in  the  feed  lots! 
through  the  winter  must  be  fed  corn,  alfalfa,  silage 
or  other  roughness,  and  the  like.  Cows  and 
heifers  (particularly  spayed  heifers),  are  sus- 
ceptible to  very  profitable  feeding  of  this  kind, 
and  loans  on  them  for  that  purpose  are  freely 


88          LOANS   AND    INVESTMENTS 

made  both  by  local  banks  and  by  loan  com- 
panies. But  here  again  the  steer  loan  has  a  little 
the  preference.  His  superior  resisting  power  in  bad 
weather,  if  nothing  else,  gives  him  an  advantage, 
according  to  general  opinion.  Banks  in  the  feeding 
country  are  larger  and  more  numerous  than  in  the 
South,  and  can  handle  a  greater  proportion  of  the 
loans  without  outside  help.  The  loans  are  likely 
to  be  smaller,  too,  as  the  cattle  will  be  handled 
in  bunches  of  moderate  size.  Nevertheless,  the 
loan  companies  do  a  considerable  business  with  the 
larger  borrowers  and  with  those  in  communities 
where  the  number  of  feeders  is  too  great  for  the 
local  bank.  Loans  by  the  companies  are  handled 
in  the  manner  already  described.  If  the  borrower 
has  plenty  of  feed  and  has  provided  water  and 
shelter,  the  full  purchase  price  is  often  loaned. 
There  are  no  requests  for  renewal  of  this  paper,  for 
the  cattle  must  go  for  killing  when  ready,  almost 
regardless  of  prices.  The  advantage  of  certain 
maturity  is  had,  but  at  the  sacrifice  of  any  oppor- 
tunity to  work  out  of  a  bad  situation.  Hogs  are 
often  put  in  the  feed  lot  to  follow  the  cattle,  and 
the  profit  in  feeding  is  not  infrequently  in  the  hogs. 
They  are  sometimes  included  in  the  mortgage  ort 
the  cattle.  Fertilizer  from  the  feed  lot,  when 
spread  on  the  fields,  is  a  most  valuable  return  to 
the  farmer,  which  should  not  be  overlooked  in  fig- 
uring his  earning  on  a  feeding  operation. 

79.    BUYING  CATTLE  LOANS.— As  already 


LOANS    AND    INVESTMENTS          89 

mentioned,  cattle  loans  bearing  the  endorsement 
of  local  banks,  for  amounts  proportionate  to  the 
bank's  business,  are  desirable  investments  by  their 
correspondents.  Other  cattle  loans  sold  to  in- 
vestors serve  the  good  purpose  of  bringing  together 
a  wholesome  industry  and  unemployed  capital. 
Well  handled  loan  companies  are  profitable  to 
all  parties.  But  there  are  dangers.  The  surplus 
of  money  in  recent  years  has  made  it  very  easy 
to  sell  paper.  Individual  bankers  situated  where 
they  can  loan  to  advantage  have  sold  a  great 
deal  of  paper  with  their  personal  endorsement. 
Most  of  this  is  undoubtedly  good,  but  tight  money, 
and  a  bad  cattle  market  when  it  is  due,  might  em- 
barrass the  endorsers.  Some  bankers  and  others 
have  organized  loan  companies  with  very  small 
capital  and  used  the  companies'  endorsement  in- 
stead of  their  own.  Not  that  loan  companies  are 
bad  because  they  are  small  and  good  because  they 
are  big,  but  the  amount  of  paper  endorsed  in  pro- 
portion to  capital  must  not  be  overlooked.  Careful 
attention  must  be  given  to  the  reputation  of  the 
pianagement,  and  to  the  personnel,  financial  associ- 
ations and  history  of  the  company.  Purchasers  of 
cattle  paper  relying  on  endorsements  should  not 
fail  to  familiarize  themselves  with  the  business  to 
the  extent  that  they  will  know  something  at  least 
as  to  the  values  represented  by  the  cattle  security, 
of  the  practices  in  their  handling,  and  the  general 
conditions  prevailing  in  the  locality. 


90          LOANS   AND   INVESTMENTS 

80.  FARMERS'  STATEMENTS.— While  ag- 
ricultural loans  are  made  in  every  State  in  the 
Union,  and  therefore  under  a  great  variety  of  con- 
ditions, those  made  on  the  general  credit  of  the  bor- 
rower must  be  very  like  all  loans  which  do  not 
carry  any  definite  security.  When  satisfied  as  to 
character,  mental  ability  and  experience,  the  banker 
will  consider  the  financial  condition  of  the  borrower. 
In  past  years  it  has  not  been  the  rule  to  require 
statements  from  farmers.  This  is  perhaps  due  to 
the  fact  that  the  land  itself,  the  improvements,  the 
crops  and  the  live  stock,  have  market  values  which 
can  be  pretty  accurately  determined  by  the  banker; 
and  the  quantity  and  quality  of  his  customers'  pos- 
sessions are  known  to  him  either  from  personal 
inspection  or  by  information  from  neighbors. 
Bankers  in  farming  communities  have  prided  them- 
selves on  knowing  their  customers,  their  families, 
their  implements,  and  even  the  individual  animals 
among  their  live  stock.  Such  knowledge  is  mani- 
festly more  intimate  and  accurate  than  can  be  had 
of  other  classes  of  borrowers.  But  while  assets  can 
be  determined  fairly  well,  liabilities  are  not  so 
easily  discovered  or  verified.  A  man  of  good  stand- 
ing may,  even  without  misrepresentation,  borrow 
as  much  from  each  of  several  banks  as  he  is  war- 
ranted in  owing  altogether.  The  Federal  Reserve 
banks  urge  that  statements  be  obtained  from  bor- 
rowers, and  require  that  statements  accompany 
notes  for  large  amounts.  The  agricultural  colleges 


LOANS   AND    INVESTMENTS          91 

are  demonstrating  the  value  of  keeping  accurate 
records  of  farm  operations,  and  are  distributing 
standard  forms  for  the  purpose.  These  influences 
aid  the  banker  in  his  purpose  to  make  his  credit 
files  confirmatory  or  independent  of  his  memory. 
Farmers  for  the  most  part  are  not  accustomed  to 
detailed  bookkeeping  and  if  blank  forms  are  handed 
to  them  to  be  filled  out  they  should  not  be  compli- 
cated. The  principal  items  in  most  localities  would 
be  the  number  of  acres  and  value  of  land  owned, 
mortgage  on  same,  value  of  town  or  city  property, 
mortgage  on  same,  number  of  head  and  value  of  live 
stock  owned,  grouped  in  kinds  and  ages,  mortgage 
on  same,  cash  on  hand  and  in  bank,  notes  and 
accounts  receivable,  indebtedness  to  the  bank  ob- 
taining the  statement,  and  list  of  other  indebted- 
ness not  secured  by  mortgage. 

81.  TACT  AND  CO-OPERATION.  —  Tact 
must  be  employed  to  obtain  even  such  a  simple 
statement  from  a  man  who  has  never  signed  one 
before,  and  the  wise  banker  will  fill  in  the  informa- 
tion while  talking  it  over  with  the  customer;  then 
ask  him  to  read  it  over;  see  if  it  is  correct,  and 
sign  it.  It  may  even  be  best  not  to  require  a  signa- 
ture the  first  time,  but  let  the  practice  of  making 
statements  gradually  become  the  custom.  It  is  in 
going  over  such  statements  from  year  to  year  with 
customers  that  the  banker  may  be  most  genuinely 
helpful  in  warning  them  against  financial  errors, 
borrowing  money  to  carry  grain  for  a  better  price 


92          LOANS   AND    INVESTMENTS 

when  they  cannot  afford  to  suffer  a  possible  drop  in 
price,  buying  more  land  than  they  can  work  or  pay 
for  in  a  reasonable  time,  buying  live  stock  when 
they  haven't  sufficient  feed  to  fatten  it;  in  fact,  the 
many  temptations  to  enter  speculative  deals  with- 
out being  able  to  absorb  a  loss.  It  is  here  also  that 
a  banker  may  discover  that  his  customer  needs  not 
a  short  time  loan  for  a  particular  purpose  but  a 
more  or  less  permanent  loan  for  operating  capital. 
A  real  estate  mortgage  loan  will  relieve  the  bor- 
rower of  frequent  renewals,  and  can  be  readily  sold 
if  desired,  so  that  the  bank  is  left  in  position  to  loan 
the  money  to  other  customers. 

82.  AGRICULTURAL  PAPER  FOR  RE- 
DISCOUNT.—When  a  banker  takes  paper  with 
the  intention  of  selling  or  rediscounting  it,  he  may 
ask  for  a  more  detailed  statement,  copies  of  which 
will  be  sent  with  the  loan.  This  may  be  a  rather 
formal  instrument,  setting  forth  the  borrower's 
name,  age,  legal  address,  with  section,  township, 
range,  county,  State  and  post  office.  The  assets 
will  include  the  homestead  less  exemption,  other 
real  estate  less  encumbrance,  personal  property  de- 
scribed in  detail  as  to  number  of  yearling  steers 
and  price  per  head,  number  two-year-old  steers  and 
price  per  head,  number  of  heifers,  one  and  two  years 
old,  with  price  per  head,  number  and  price  per  head 
of  cows,  calves,  bulls,  horses,  mules,  sheep,  hogs, 
etc.,  amount  and  value  of  feed  on  hand,  corn,  oats, 
alfalfa,  other  hay,  sorghums,  silage,  other  feed,  etc., 


LOANS    AND    INVESTMENTS          93 

cash  in  bank  with  name  of  bank,  other  grains  or 
staples,  description  and  value  of  all  notes  and  ac- 
counts receivable,  and  other  personal  property.  The 
liabilities  will  include  encumbrance  on  live  stock 
described  in  detail,  with  name  of  mortgagee,  date, 
property  covered,  due  date,  rate  of  interest,  etc., 
other  borrowed  money  itemized,  amount  due  rela- 
tions itemized,  all  other  debts  itemized.  The  state- 
ment will  contain  information  about  any  leases  to 
which  the  borrower  is  a  party,  as  to  judgments  or 
suits  pending  against  him,  how  long  he  has  lived 
at  present  address,  where  he  formerly  lived,  names 
and  addresses  of  references,  whether  he  is  surety 
on  any  notes  or  bonds  of  other  makers.  Such 
declaration  may  even  be  sworn  to  before  a  notary 
public.  Such  statements  are  not  infrequently  re- 
quired from  large  borrowers  even  though  the  loans 
to  them  are  secured  by  chattel  mortgages.  A 
strong  showing  outside  of  the  property  covered 
by  the  mortgage  helps  the  sale  of  the  paper. 

83.  IMPORTANCE  OF  PURPOSE.— When 
satisfied  as  to  the  character,  ability  and  financial 
responsibility  of  the  customer,  the  banker  may  still 
hesitate  before  making  a  loan  until  he  has  learned 
what  the  money  is  to  be  used  for,  and  whether  pro- 
vision has  been  made  for  payment  at  maturity.  It 
is  true  that  in  localities  where  loanable  funds  in 
banks  regularly  exceed  the  demand,  notes  of  good 
makers  are  renewed  regularly  with  no  suggestion 
that  they  be  paid.  Just  as  in  loans  to  merchants 


94          LOANS   AND    INVESTMENTS 

or  manufacturers,  these  may  have  grown  out  of 
short  time  notes  given  to  cover  particular  opera- 
tions, but  the  makers  finding  it  profitable  to  con- 
tinue using  the  funds,  and  the  banks  being  satisfied 
the  paper  is  good,  more  or  less  permanent  loans 
are  the  result.  It  is  not  contended  that  this  prac- 
tice is  necessarily  wholly  bad,  but  loans  of  such 
character  should  not  be  allowed  to  form  too  great 
a  proportion  of  the  bank's  investments.  Particu- 
larly in  a  community  where  the  demand  for  funds 
exceeds  the  local  supply,  continuing  loans  are 
likely  to  cause  careless  planning  on  the  part  of  the 
makers,  and  to  injure  the  bank  by  restricting  its 
ability  to  serve  the  whole  community,  or  to  liquidate 
deposits  when  called  on.  The  normal  agricultural 
loan  is  self-liquidating.  Money  borrowed  to  buy 
cattle  for  fattening  or  to  be  used  for  seed  or  for 
planting,  cultivating,  harvesting  or  marketing 
crops,  will  be  paid  when  the  cattle  or  the  crops  are 
ready  for  sale.  Various  expense  items  are  naturally 
included,  such  as  cost  of  feed  for  work  animals, 
wages  of  employees,  family  living  expenses,  imple- 
ments, etc.  It  is  the  part  of  the  good  banker  to 
judge  whether  the  amount  he  is  to  furnish  is  justi- 
fied by  the  probability  of  returns  from  the  enter- 
prise and  the  ability  of  the  borrower  to  pay  if  it 
proves  unprofitable.  Generally  speaking,  normal 
loans  to  farmers  and  live  stock  men  of  responsibility 
and  experience  are  ideal  from  the  banking  stand- 
point. When,  however,  cattle  or  sheep  are  bought 


LOANS   AND    INVESTMENTS          95 

with  the  idea  of  catching  a  quick  upturn  in  price, 
or  when  staples  are  held  for  an  advance  and  not 
because  of  inability  to  dispose  of  them  rapidly,  then 
a  loan  is  no  longer  a  normal  one  for  agricultural 
purposes,  but  a  loan  for  speculation  in  agricultural 
products,  and  should  be  treated  accordingly. 

84.  COUNTRY  BANKING  PROBLEMS.— 
Loans  are  based  in  some  States  almost  entirely 
upon  the  borrower's  general  assets;  that  is,  a  mort- 
gage on  personal  property  is  very  rarely  taken.  In 
other  sections,  chattel  mortgages  secure  nearly 
every  loan  made  by  banks.  This  is  particularly 
true  in  newly  settled  communities,  where  the  bor- 
rowers have  limited  means  and  have  not  established 
records  as  to  character.  The  laws  aff ecting  chattel 
mortgages  differ  in  the  various  States  as  to  place 
of  filing  for  record,  etc.  It  is  always  well  to  remem- 
ber two  things  in  handling  this  class  of  paper. 
Have  the  wife  sign  the  note  and  mortgage  with 
the  husband,  whether  necessary  under  the  law  or 
not,  and  describe  the  property  in  the  mortgage  so 
accurately  and  minutely  that  identification  will  be 
easy  and  unmistakable.  Loans  of  this  kind  usually 
pay  a  high  rate  of  interest,  are  for  small  amounts, 
and  are  troublesome  as  well  as  risky.  They  furnish 
practically  the  only  means,  however,  of  financing 
people  who  may  later  become  good  depositors. 
Loans  to  tenants  are  similar  to  those  just  described. 
Bankers  who  find  it  possible  to  keep  sufficient  funds 
employed  otherwise,  often  refuse  to  make  tenant 


96          LOANS   AND   INVESTMENTS 

loans.  While  they  admit  that  tenant  farming  is 
a  growing  menace,  and  that  some  of  them  may  be 
helped  to  become  landowners  by  judicious  as- 
sistance from  a  bank,  still  the  risk  is  something, 
the  annoyance  is  worse,  the  public  criticism  on  the 
foreclosure  of  a  mortgage  is  embarrassing,  and,  as 
one  man  said,  "if  they  are  any  good,  they  don't 
remain  tenants  long."  Increasing  land  values  is 
making  it  harder  every  year  for  a  man  to  rise  to 
ownership,  and  the  problem  of  financing  such  ad- 
vancement should  be  studied  in  broad  and  patriotic 
spirit.  Young  men,  sons  of  well-to-do  parents,  who 
begin  their  independent  careers  on  rented  farms, 
and  with  barely  adequate  equipment,  are  entitled 
to  a  special  classification.  They  may  rely  on  some 
parental  assistance  if  it  is  absolutely  necessary  and 
on  an  inheritance  some  time  in  the  future.  Prefer- 
ring to  set  up  their  own  households,  they  undertake 
farming  on  their  own  account.  If  they  show 
good  judgment  in  their  undertakings,  and  bear 
favorable  reputations,  the  banker  has  an  oppor- 
tunity to  help  develop  these  young  men  in  a  busi- 
ness way,  and  to  cement  them  to  his  institution  by 
making  them  moderate  loans  without  their  fathers' 
endorsement,  or  other  security. 


CHAPTER  III 

Stocks  and  Bonds 

85.  OWNERSHIP  AND  INDEBTEDNESS. 
— The  words  "stocks"  and  "bonds"  have  until  re- 
cently been  applied  indiscriminately  to  the  financial 
obligations  of  governments.  Some  of  the  early 
certificates  of  indebtedness  of  the  United  States 
were  known  as  "stocks,"  and  the  same  name  still 
clings  to  certain  obligations  of  the  city  of  New 
York.  In  the  language  of  modern  finance,  how- 
ever, bonds  are  certificates  of  indebtedness  and 
stocks  are  certificates  of  ownership.  In  incorpor- 
ated companies  bonds  represent  specific  liens  on 
property  possessed,  and  stocks  represent  the  prop- 
erty itself.  In  other  words,  the  owner  of  stock 
in  a  company  is  a  part  owner  of  the  company,  and 
participates  in  the  profits  and  losses,  while  an 
owner  of  bonds  issued  by  the  same  company  is 
interested  in  the  success  of  the  company  only  in 
so  far  as  the  security  and  punctual  payment  of  such 
bonds,  principal  and  interest,  are  concerned.  The 
bondholder  has  no  part  in  the  operation  of  the 
company;  ordinarily  he  has  no  voice  in  its  man- 
agement; in  short,  he  is  merely  a  creditor;  while 
the  stockholder  possesses  a  definite  ownership 
interest  in  the  company  in  proportion  to  the  amount 
of  stock  owned  by  him.  The  bondholder  is  not 
responsible  for  the  success  or  failure  of  the'enter- 

97 


98          LOANS    AND    INVESTMENTS 

prise,  while  the  stockholder,  in  addition  to  the 
privileges  which  go  with  his  stock,  has  that  re- 
sponsibility and  obligation  which  attaches  to 
ownership. 

86.    STOCKS    AND    THEIR    CLASSIFICA- 
TION.— When  a  company  or  corporation  is  or- 
ganized, money  or  other  things  of  tangible  value 
which  are  invested  in  or  contributed  to  the  enter- 
prise  by   the   organizers   are   known  as   capital. 
Such  capital  is  evidenced  by  proportionate  shares 
of  value  denominated  capital  stock.    As  a  matter 
of  convenience  this  stock  is  divided  into   equal 
parts,   usually   of  $100  each,  termed  "shares  of 
stock."    The  total  amount  of  stock  which  may  be 
issued  is  fixed  by  the  charter  of  the  corporation. 
To  evidence  the  ownership  of  these  shares,  cer- 
tificates of  stock  are  issued  to  holders  in  amounts 
equal  to  the  number  of  shares  owned.     Thus,  a 
stockholder  owning  $5,000  worth  of  the  capital 
stock  will  have  a  certificate  or  certificates  repre- 
senting 50  shares  of  $100  each.    These  certificates 
specify  the  number  of  shares  owned,  the  par  value, 
and  certain  other  facts,  as  for  instance,  whether 
the  stock  is  common  or  preferred,  assessable,  full- 
paid  or  not.     Generally  speaking,  there  are  two 
classes  of  stock,  "common"  and  "preferred,"  and 
the  usual  relation  that  each  bears  to  the  other  is 
indicated  by  their  respective  names. 

87.     COMMON  STOCK.— The  control  or  man- 
agement of  a  corporation,  as  a  general  rule,  vests 


LOANS   AND    INVESTMENTS          99 

in  the  ownership  of  common  stock.  Ordinarily  the 
possession  of  a  share  of  common  stock  entitles  the 
registered  holder  thereof  to  a  vote  at  recurring 
stated  periods  for  the  legally  constituted  repre- 
sentatives of  the  stockholders  in  the  management 
of  the  affairs  of  the  corporation.  Such  representa- 
tives are  usually  termed  directors,  and  hold  their 
authority  by  reason  of  a  preference  expressed  for 
them  by  the  owners  of  a  majority  in  shares  of  the 
common  stock  of  the  corporation.  Directors,  when 
elected  and  during  their  term  of  office,  have  well 
defined  rights  and  powers  as  to  the  determination 
of  corporate  policy  and  the  appointment  of  execu- 
tive officers,  but  being  compelled  at  definite  times 
to  relinquish  office,  are  subject  to  the  owners  of 
a  majority  number  of  shares  of  common  stock. 
The  right  of  common  stockholders  to  have  a  voice 
in  determining  corporate  policy  usually  makes 
common  stock  more  eagerly  sought  for  in  open 
market  and  renders  unnecessary  the  payment  of 
large  dividends.  Ordinarily  the  amount  of  divi- 
dends paid  upon  common  stock  is  less  in  amount 
than  that  paid  upon  preferred  stock.  In  some 
instances,  however,  common  stock  dividends  ex- 
ceed in  amount  those  of  preferred  stock.  In  some 
great  corporations,  such  as  the  Pennsylvania 
Railroad  Company,  common  is  the  only  class  of 
stock  issued,  while  in  the  Great  Northern  Railway 
Company  preferred  alone  is  outstanding.  The 
rights  of  common  stockholders  are  very  minutely 


100        LOANS   AND    INVESTMENTS 

defined  by  law  and  very  zealously  protected  by 
courts.  Except  where  otherwise  determined  by 
charter  or  contract  provision,  the  ultimate  rights 
of  common  and  preferred  stock  in  a  liquidation 
of  corporate  assets  are  similar. 

88.  PREFERRED  STOCK.— Ordinarily  pre- 
ferred stock  has  no  voting  power,  and  is  therefore 
not  of  value  in  determining  corporate  policy.  Pre- 
ferred stock  is  primarily  an  investment  stock,  and 
is  issued  in  such  form  and  with  such  preferences! 
as  to  assets  and  dividends,  over  common  stock, 
as  to  cause  its  ready  absorption  by  the  purchasing 
public,  and  thus  provide  funds  for  corporate  ex- 
tension and  development.  The  rates  of  dividends 
are  usually  fixed  in  amount  and  unearned  divi- 
dends are  usually  made  cumulative.  By  cumula- 
tive dividends  are  meant  those  dividends  which, 
if  not  paid  one  year,  must  be  paid  in  some  succeed- 
ing year,  at  the  fixed  rate  provided  for,  together 
with  all  dividends  which  have  subsequently  ac- 
crued. Oftentimes  a  minimum  rate  of  dividend 
is  fixed  with  a  provision  for  an  increase  in  propor- 
tion to  and  in  common  with  the  rate  of  dividend 
declared  on  an  outstanding  issue  of  common  stock. 
Preferred  stock  is  usually  preferred  as  to  assets 
in  corporate  liquidation  over  common  stock.  In 
case  of  failure  to  pay  the  fixed  rate  of  dividend 
for  a  stated  period  of  time,  the  right  of  holders 
of  shares  of  preferred  stock  to  vote,  and  of  a 
determined  number  of  shares  to  control  corporate 


LOANS   AND   INVESTMENTS        10i' 

policy  until  resumption  of  dividends,  is  often  ac- 
corded in  an  indenture  providing  the  terms  under 
which  the  stock  is  issued.  Preferred  stock  has  of 
late  years  more  largely  assumed  the  nature  of  a 
preferred  investment,  and  sinking  funds  derived 
from  earnings  have  been  created  for  the  redemp- 
tion of  preferred  stock  in  definite  annual  amounts 
at  a  fixed  price  or  such  lower  price  as  may  be 
determined  by  open  market  purchases. 

89.  FULL  PAID  STOCK.— When  a  corpora- 
tion has  received,  either  in  cash  or  other  value 
permitted  by  law,  the  full  face  of  stock,  such  stock 
is  known  as  "full  paid,"  and  that  fact  is  so  indi- 
cated on  the  certificates.     If  not  full  paid,  the 
holder  may  be  held  liable  for  the  unpaid  portion, 
unless  it  is  expressly  stipulated  by  agreement  that 
the  share  may  be  sold  for  less  than  its  face  value 
with  the  understanding  that  it  may  be  considered 
full  paid.    When  a  corporation  has  not  received 
its  full  value  for  stock  which  has  been  issued,  al- 
ways excepting  a  reasonable  deduction  for  mar- 
keting expense,  such  stock  is  known  as  "watered 
stock."    This  term  as  usually  employed  applies  to, 
stock  which  has  been  issued  in  payment  for  prop- 
erty or  services  which  have  been  given  a  value 
in  excess  of  their  true  worth,  or  which  represent 
expected  future  value. 

90.  TREASURY   STOCK.— "Treasury  stock" 
is  capital  stock  which  has  been  authorized  and 
issued,  but  instead  of  being  sold  or  disposed  of  in 


102        LOANS    AND    INVESTMENTS 

some  other  way,  is  held  in  the  treasury  indefinitely; 
or  which,  having  been  outstanding  in  the  hands  of 
the  public,  has  been  purchased  by  the  company  and 
not  cancelled.  Such  stock  is  an  asset  of  the  com- 
pany, but  it  cannot  be  represented  by  a  vote  in  the 
meetings  of  the  company,  nor  does  it  ordinarily 
draw  dividends. 

91.  CERTIFICATES  OF  STOCK.— A  "cer- 
tificate of  stock"  to  be  legal  must  be  signed  by  the 
authorized  officials  of  the  company  and  sealed  with 
the  corporate  seal.    It  must  also  specify  the  number 
of  shares  represented  and  must  bear  the  name  of 
the  registered  stockholder.    The  certificate  of  stock 
is  not  capital,  but  merely  the  evidence  of  ownership 
of  capital,  in  the  same  sense  as  a  deed  to  a  piece  of 
land  is  the  evidence  of  ownership  of  the  land.  Stock 
certificates  of  a  corporation  are  usually  kept  in  the 
custody  of  a  proper  official,  generally  the  secretary, 
and  bound  in  a  volume  with  a  stub  for  recording 
each  certificate  issued.    This  stub  bears  the  essen- 
tial facts  concerning  the  certificate.    If  the  certifi- 
cate is  cancelled  it  must  be  returned  to  the  conn 
pany  and  is  attached  to  its  original  stub.    Certifi- 
cates of  stock  may  be  transferred  the  same  as  any 
other  evidence  of  ownership,  but  the  voting  power 
of  such  new  stock  is  not  transferred  until  a  record 
of  such  transfer  has  been  made  on  the  books  of  the 
company. 

92.  VOTING  TRUST  CERTIFICATES.— In 
the  modern  development  of  corporate  finance  an 


LOANS   AND    INVESTMENTS        103 

instrument  of  practical  value  has  come  into  wide 
use.  It  is  termed  the  "voting  trust."  The  voting 
trust  is  an  agreement  whereby  the  holders  of  the 
common  or  other  controlling  stock  of  a  corporation 
agree  to  relinquish  for  a  definite  period  their  rights 
of  control  in  corporate  affairs  to  one  or  more  in- 
dividuals, called  voting  trustees,  who  during  the 
life  of  the  agreement  act  for  them  in  the  administra- 
tion of  corporate  affairs,  electing  directors  and  per- 
forming the  ordinary  functions  of  stockholders.  A 
voting  trust  is  usually  the  corollary  of  internal  dis- 
sension or  financial  reorganization,  and  is  used  to 
insure  the  restoration  of  confidence  or  the  protec- 
tion of  money  advanced  to  restore  the  credit  stand- 
ing of  the  corporation  involved.  Voting  trust  cer- 
tificates have  the  attributes  of  stock  certificates 
and  are  assigned  and  transferred  in  similar  ways. 
93.  SHARES  WITHOUT  PAR  VALUE.— It 
has  long  been  customary  to  issue  stock  of  a  fixed 
par  value,  usually  $100,  the  same  having  no  rela- 
tion to  the  intrinsic  value  of  the  shares  or  to  their 
selling  price.  In  new  companies,  stock  of  fixed  par 
value  has  sometimes  been  sold  at  one-tenth  of  that 
value,  such  transactions  indicating  depreciation  in 
the  value  of  the  stock  or  the  fictitious  nature  of  the 
par  value.  In  the  last  analysis,  a  share  of  stock  is  a 
certificate  of  ownership  of  a  specific  part  of  a  busi- 
ness. The  precise  value  of  such  specific  part  is 
determined  by  an  inventory  and  a  financial  state- 
ment. The  par  value  has  no  bearing  upon  its  actual 


104        LOANS   AND   INVESTMENTS 

value,  except  in  so  far  as  it  represents  a  fixed  unit 
of  proportional  ownership.  The  market  price  of  a 
share  of  stock  is  dependent,  in  large  measure,  upon 
supply  and  demand,  irrespective  of  the  intrinsic 
value  disclosed  by  the  corporate  books.  To  actu- 
ally fix  the  true  value  of  a  share  of  stock  and  to 
prevent  as  far  as  is  possible  the  issuance  of  stock 
having  a  value  fictitious,  and  not  intrinsic,  confus- 
ing in  public  service  corporations  the  relation  which 
rates  and  earnings  should  bear  to  actual  capital 
investment,  the  certificate  of  stock  having  a  par 
value  has  been  abandoned  in  some  States  and  cer- 
tificates bearing  proportionate  value  issued  in  place 
thereof.  Such  certificates  are  accorded  a  face  value 
of  the  actual  original  amount  paid  therefor,  values 
being  determined  by  the  proportion  of  value  which 
each  certificate  bears  to  the  actual  capital  value  of 
the  corporate  enterprise. 

94.  MANAGERS'  SHARES.— A  recent  inno- 
vation in  corporate  finance  is  the  issuance  of  what 
are  termed  "managers'  shares."  Such  shares  are 
shares  set  aside  by  a  corporation  for  purchase  by, 
or  presentation  to,  persons  who  are  engaged  in  the 
active  management  of  the  corporation.  These 
shares,  limited  in  amount,  usually  pay  a  larger  divi- 
dend after  the  regular  dividend  distribution  than 
do  the  ordinary  shares  of  the  company.  Thus  the 
excess  profits  are  in  measure  distributed  among 
the  men  who  through  their  efforts  created  the 
larger  earning  power  of  the  corporation.  In  the 


LOANS   AND   INVESTMENTS        105 

American  International  Corporation,  a  recent  de- 
velopment in  American  finance,  provision  is  made 
that  if  at  any  time  one  of  the  owners  of  the  "man- 
agers' shares"  resigns  from  active  management  of 
the  company,  or  is  dismissed  by  the  directors,  he 
must  sell  his  managers'  stock  to  the  corporation  at 
par  or  an  appraised  price,  the  same  to  be  taken  up 
by  the  man  who  replaces  him  in  the  service  of  the 
company. 

95.  TRANSFER  OF  STOCKS.— On  one  side 
of  a  certificate  of  stock  there  is  a  blank  form  of 
assignment  and  power  of  attorney  to  transfer, 
which  may  be  filled  out  by  the  owner  when  the 
stock  is  delivered  to  another  person,  with  the  name 
of  such  person,  or  may  be  signed  in  blank  and  de- 
livered. In  most  States  stock  so  transferred  carries 
full  legal  title,  although  in  a  few  States  registry 
must  be  made  on  the  books  of  the  company,  to 
protect  the  transferee  against  the  claims  of  a  sub- 
sequent attaching  creditor  of  the  transferor  who, 
serving  a  writ  of  attachment  upon  the  company 
while  the  stock  remains  registered  in  the  name  of 
the  transferor,  will  acquire  superior  rights  to  the 
prior  unrecorded  transferee.  Furthermore,  the 
transfer  of  a  certificate  of  stock  is  not  complete  so 
far  as  the  company  is  concerned  until  the  transfer 
is  recorded  on  the  books.  Prior  to  that  time  the 
transferee  would  have  no  voice  in  the  management 
of  the  affairs  of  the  company  and  the  latter  would 
be  protected  in  paying  dividends  to  the  former 


106        LOANS    AND    INVESTMENTS 

owner  who  would  still  appear  as  owner  of  record. 
A  further  point  to  be  observed  by  purchasers  or 
lenders  of  money  upon  shares  of  stock  is  whether 
the  stock  is  subject  to  any  lien  of  the  company  for 
indebtedness  of  the  transferor.  The  laws  on  this 
subject  in  the  different  States  vary  greatly;  in  some 
States  the  company  cannot  acquire  such  a  lien  while 
in  other  States  the  company  is  given  a  lien  or  right 
to  refuse  transfer  until  the  indebtedness  of  the 
owner  of  record  is  satisfied.  This  right  of  lien  is 
sometimes  expressly  given  by  statute  and  some- 
times created  in  other  ways.  The  full  negotiability 
which  attaches  to  bills  and  notes  does  not  in  all 
cases  attach  to  certificates  of  stock.  For  example, 
the  New  York  courts  have  held  that  where  a  stock 
certificate  has  been  signed  in  blank  and  lost  or 
stolen,  the  real  owner  does  not  lose  his  title  to  an 
innocent  purchaser  from  the  thief  or  finder;  but 
where  there  has  been  unauthorized  dealing  with 
such  a  certificate,  the  innocent  purchaser  is  gener- 
ally protected  on  the  theory  of  estoppel  if  the  real 
owner's  negligence  contributed  to  the  misappro- 
priation. 

96.  STOCK  TRANSFER  AGENTS.— With 
the  development  of  large  business  through  corpo- 
rate means,  most  of  the  larger  corporations  find  it 
expedient — in  fact  quite  necessary — to  appoint  a 
"transfer  agent,"  who  exercises  entire  supervision 
of  the  issue  and  transfer  of  their  stock;  and  because 
of  the  predominance  of  New  York  City  as  a  stock 


LOANS   AND   INVESTMENTS        107 

market,  a  very  large  percentage  of  such  agents  are 
located  in  that  city.  These  transfer  agents  are 
usually  banks  or  trust  companies,  by  whose  selec- 
tion the  corporation  is  assured  of  responsibility, 
reliability  and  accuracy,  all  of  which  are  essential. 
Indeed  so  thoroughly  precise  must  the  transfer 
agent  be  that  occasionally  he  is  accused  of  being 
unnecessarily  technical.  The  reason  for  the  exer- 
cise of  such  extreme  care  may  be  found  in  the  fol- 
lowing extract  from  the  court  decision  in  a  recent 
case  involving  the  transfer  of  securities:  "It  is  the 
duty  of  such  a  corporation,  before  making  such  a 
transfer,  to  be  satisfied  of  the  genuineness  of  the 
power  presented.  In  so  doing,  it  must  act  on  its 
own  responsibility  and  incur  its  own  risk  of  being 
misled  by  forgery  or  fraud,  and  it  is  no  answer  to  a 
claim  put  forward  by  the  true  owner  that  the  com- 
pany acted  in  good  faith  upon  what  it  supposed  to 
be  genuine  authority,  and  without  negligence." 

97.  BONDS  AND  THEIR  CLASSIFICA- 
TION.— A  bond  is  a  contract  between  one  party 
desiring  funds  and  another  party  having  funds  to 
invest.  It  is  a  promise  by  the  borrower  to  pay  to 
the  lender  at  a  definite  future  time  with  interest  a 
certain  sum  of  money.  The  proper  classification  of 
bonds  is  difficult  owing  to  their  multiplicity  and 
the  ingenuity  displayed  in  inventing  new  kinds  and 
new  names.  Bonds  may  be  classified  according  to 
(1)  the  character  of  the  obligor,  (2)  the  purpose  or 
function  of  issue,  (3)  the_  character  of  security, 


108        LOANS   AND   INVESTMENTS 

(4)  the  conditions  of  payment  of  principal  and  in- 
terest, (5)  the  evidence  of  ownership  and  transfer. 
98.  CLASSIFICATION  ACCORDING  TO 
CHARACTER  OF  OBLIGOR.  —  In  accordance 
with  the  character  of  the  obligor  bonds  are  classi- 
fied as  "civil  bonds"  and  "corporation  bonds." 
"Civil  bonds"  include  Government  bonds,  National 
and  State,  and  municipal  bonds.  "Government 
bonds"  include  United  States  bonds,  bonds  of 
United  States  territories  and  dependencies,  and 
bonds  of  the  various  States  that  constitute  the 
nation.  "Municipal  bonds"  include  bonds  of  coun- 
ties, cities,  townships,  villages,  and  tax  districts. 
"Corporation  bonds"  are  classified  as  railroad 
bonds,  public  utility  bonds,  industrial  bonds,  timber 
bonds,  shipping  bonds,  and  miscellaneous  bonds. 
"Railroad  bonds"  consist  of  bonds  of  railroads, 
steam  or  electric.  "Public  utility  bonds"  consist 
of  bonds  of  street  railway,  gas,  electric  light  and 
power,  water,  water  power,  and  telephone  corpor- 
ations. The  terms  "industrial,"  "timber"  and 
"shipping"  bonds  are  self-explanatory;  "miscel- 
laneous bonds"  include  corporate  reclamation 
bonds,  real  estate  bonds  and  mining  company 
bonds.  "United  States  Government  bonds"  are 
those  issued  by  the  United  States  Government 
for  public  purposes.  Their  purposes  of  issue  are 
naturally  broader  in  scope  than  either  State  or 
municipal  bonds.  Among  the  various  purposes 
for  which  Government  bonds  are  issued  are  con- 


LOANS   AND    INVESTMENTS        109 

struction  and  maintenance  of  interstate  canals,  cost 
of  wars,  improvements  in  the  Philippine  Islands 
and  other  territories  and  dependencies,  and  the 
Panama  Canal.  Most  United  States  bond  issues 
are  purchased  by  bond  houses,  but  occasionally 
there  has  been  a  popular  bond  issue,  subscriptions 
to  which  have  been  extended  to  small  purchasers. 
There  are  certain  public  duties  to  be  performed  by 
a  State  government,  such  as  building  highways, 
canals,  State  schools  for  various  purposes,  and 
charitable  institutions,  all  of  which  may  be  the  sub- 
ject of  bond  issues,  the  payment  of  which  may  be 
provided  by  taxation  in  the  same  manner  as  with 
municipal  bonds. 

99.  CLASSIFICATION  ACCORDING  TO 
PURPOSE  OF  ISSUE.— Among  the  bonds  which 
derive  their  titles  from  the  purpose  of  issue,  are  ad- 
justment bonds,  income  bonds,  construction,  equip- 
ment trust,  extension,  improvement,  purchase 
money,  refunding  and  terminal  bonds.  "Adjust- 
ment bonds"  are  issued  to  enable  a  company  to  ad- 
just its  finances  or  for  the  purpose  of  adjusting  the 
interests  of  two  or  more  corporations.  "Income 
bonds"  are  general  obligations  ranking  in  lien  after 
all  specifically  secured  bonds,  the  interest  on  which 
is  payable  only  when  earned  as  income,  and  in  the 
amount  determined  by  the  directors.  "Construc- 
tion bonds,"  as  their  name  implies,  are  for  the  pur- 
pose of  erecting  new  buildings,  or  in  the  case  of  a 
railroad,  new  trackage,  and  as  a  rule  are  secured  by 


110        LOANS    AND    INVESTMENTS 

a  first  mortgage  on  the  property.  A  progressive 
railroad  is  under  constant  necessity  of  increasing 
its  equipment,  and  therefore  "equipment  trust 
bonds,'*  or  notes,  are  issued,  and  the  money  thus 
raised  is  used  for  this  purpose.  Such  bonds  are 
secured  by  the  equipment  purchased.  "Extension 
bonds"  are  issued  primarily  for  the  purpose  of  ex- 
tending the  main  line  of  a  railroad  from  one  point 
to  another.  "Improvement  bonds"  are  issued  for 
the  purpose  of  repairs  and  improvement  on  a  prop- 
erty. These,  in  the  case  of  a  railroad,  may  include 
buildings,  stations,  trackage,  rights  of  way,  and 
switch  yards.  "Purchase  money  bonds"  are  those 
which  are  used  as  part  consideration  in  the  purchase 
of  properties.  "Refunding  bonds"  are  issued  for 
the  purpose  of  procuring  funds  which  shall  be  used 
in  retiring  outstanding  issues  of  bonds.  Sometimes 
this  is  done  to  secure  a  lower  interest  rate  and 
sometimes  in  order  to  take  care  of  maturing  obliga- 
tions. "Terminal  bonds"  are  usually  issued  by 
subsidiary  companies  organized  to  hold  title  to 
terminal  stations  and  properties  for  one  or  more 
railroad  companies. 

100.  CLASSIFICATION  ACCORDING  TO 
CHARACTER  OF  SECURITY.— Based  on  their 
security,  bonds  are  divided  into  two  classes,  "unse- 
cured" and  "secured."  Federal  Government,  State 
and  municipal  bonds,  while  secured  by  legislative 
lien  on  tax  revenues,  are  generally  termed  unse- 
cured bonds.  They  are  unsecured  because  accom- 


LOANS   AND    INVESTMENTS        111 

panied  by  no  collateral  contract,  such  as  is  the  case 
with  the  majority  of  railroad,  public  utility  and  in- 
dustrial bonds.  "Secured  bonds"  include  such  as 
have  back  of  them  actual  value,  which  may  be  ob- 
tained by  the  bondholder  through  legal  action  in 
case  of  default  in  payment  of  the  bonds.  Among 
the  various  kinds  of  secured  bonds  may  be  men- 
tioned "land  grant  bonds,"  the  security  for  which  is 
a  mortgage  on  the  lands  involved ;  "real  estate  rail- 
road bonds,"  secured  by  a  mortgage  on  real  prop- 
erty not  actually  used  in  the  operation  of  the  road; 
"sinking  fund  bonds,"  secured  by  a  fund  created  by 
a  contract  which  is  usually  in  the  hands  of  a  disin- 
terested trustee;  collateral  trust  bonds  secured  by 
specifically  pledged  personal  property  of  the  bor- 
rower, "prior  lien,"  "first,"  "second,"  "third"  and 
"general"  mortgage  bonds,  the  security  for  which 
is  indicated  by  their  titles. 

101.  CLASSIFICATION  ACCORDING  TO 
CONDITIONS  OF  PAYMENT.— Bonds  which 
are  classified  in  this  manner  include  "gold,"  "silver," 
"currency,"  "legal  tender,"  "callable,"  "convertible" 
and  "joint"  bonds.  "Gold,"  "silver,"  "currency" 
and  "legal  tender"  bonds  are  payable  as  indicated 
by  their  titles  in  the  kind  of  money  described. 
Practically  all  railroad  bonds  are  gold  bonds  and 
therefore  payable  in  gold.  Some  Mexican  and 
South  American  bond  issues  are  payable  in  silver. 
Ohio,  Southern,  and  Western  municipal  bonds  are 
frequently  paid  in  currency  or  legal  tender.  "Call- 


112        LOANS   AND   INVESTMENTS 

able  bonds"  are  those  which  may  be  paid  before 
maturity  at  a  rate  specified  in  the  bond,  which  is 
usually  above  the  par  value.  Fully  three-quarters 
of  outstanding  railroad  bonds  are  callable.  Union 
Pacific  First  Lien  and  Refunding  4s,  due  in  2008, 
are  callable,  for  instance,  in  1918,  at  107^  and 
interest.  "Convertible  bonds"  are  those  which 
permit  the  holder  to  exchange  or  convert  them 
at  a  specified  rate  into  other  forms  of  property, 
usually  into  common  stock  of  the  issuing  company. 
"Joint  bonds"  are  those  whose  security  for  payment 
is  the  responsibility  of  two  or  more  corporations. 

102.  CLASSIFICATION   ACCORDING   TO 
OWNERSHIP  AND  TRANSFER.— Under  this 
classification  there  are  three  kinds  of  bonds,  "cou- 
pon," "registered"  and  "registered  coupon."   "Cou- 
pon bonds"  are  those  which  contract  for  the  pay- 
ment of  interest  by  means  of  separate  coupons  for 
fixed  amounts  payable  at  stated  intervals.    These 
coupons  may  be  detached  and  presented  for  pay- 
ment the  same  as  any  promissory  note.    "Regis- 
tered bonds"  are  those  which  are  recorded  with  the 
registrar  of  the  bond  issue,  and  transfer  of  the  title 
to  same  in  order  to  be  legal  must  be  made  with  such 
registrar.    In  the  case  of  registered  bonds  interest 
payments  are  made  only  to  the  registered  holders 
or  upon  their  order.    "Registered  coupon  bonds" 
are  those  the  principal  of  which  is  registered,  the 
coupons  being  made  payable  to  bearer. 

103.  MUNICIPAL  BONDS.— Broadly  speak- 


LOANS    AND    INVESTMENTS        113 

ing,  any  bond  issued  by  the  general  government  or 
any  subdivision  of  the  general  government,  such  as 
State,  county  or  city,  is  a  "municipal"  bond,  but  in 
the  general  acceptation  of  the  term  a  "municipal" 
bond  is  one  issued  by  a  county,  city  or  town,  for 
the  purpose  of  providing  funds  for  public  works  or 
improvements  therein.  Such  bonds  may  be  issued 
for  the  erection  of  a  schoolhouse,  and  be  known  as 
"school  bonds,"  but  must  be  paid  by  taxes  levied 
upon  the  people  in  the  municipality  or  school  dis- 
trict issuing  the  same.  Bonds  for  street  improve- 
ment, sewers,  waterworks,  or  drainage,  issued  by 
a  municipality  or  a  subdivision  thereof,  come  under 
the  heading  of  "municipal  bonds,"  and  their  pay- 
ment is  provided  for  in  the  same  way.  In  consid- 
ering municipal  bonds  as  an  investment,  the  first 
and  fundamental  consideration  is  that  of  legality. 
It  has  sometimes  happened,  even  after  all  legal 
phases  of  an  issue  have  been  carefully  scrutinized 
by  capable  lawyers,  that  some  hidden  point  has 
been  discovered  which  has  invalidated  the  entire 
issue.  Generally  speaking,  a  municipal  bond  issue, 
in  order  to  be  legal,  must  be  in  accordance  with  the 
constitution  of  the  United  States  and  must  be  auth- 
orized by  the  constitution  and  statutes  of  the  State 
in  which  the  municipality  is  located.  Strict  compli- 
ance with  all  terms  of  statutes  is  absolutely  neces- 
sary. After  the  legality  of  a  municipal  bond  issue 
has  been  established,  the  investor  should  assure 
himself  that  there  is  a  sufficient  amount  of  taxable 


114        LOANS    AND    INVESTMENTS 

property  within  the  district  to  insure  the  payment 
of  the  interest  and  principal  of  the  bonds.  He  should 
satisfy  himself  also  as  to  the  financial  record  of  the 
municipality.  The  serial  municipal  bond  is  gradu- 
ally displacing  the  long  term  bond  of  fixed  exist- 
\ence,  and  the  sinking  fund  bond,  and  is  in  accord 
with  soundest  principles  of  municipal  finance. 

104.  RAILROAD  BONDS.— The  railroads  are 
the  highways  of  the  nation  and  are  absolutely  nec- 
essary to  its  development.  The  properly  issued  and 
well  secured  bonds  of  well  managed  and  honestly 
financed  railroads  are  premier  corporate  securities. 
The  classifications  of  railroad  securities  are  most 
numerous,  and  are  the  result  of  methods  used  in  ob- 
taining great  sums  of  money  demanded  by  rapid  de- 
velopment. "General  mortgage  bonds,"  last  in  lien 
when  originally  issued,  have  become  first  mort- 
gages on  a  majority  in  mileage  of  main  line  track, 
and  first  mortgage  bonds  may  be  a  lien  on  a  limited 
mileage  of  secondary  trackage.  Discrimination 
and  careful  investigation  are  essential  to  safety,  and 
the  last  mortgage  on  a  well  established  line  is  often 
better  security  than  a  first  mortgage  on  a  newer 
road,  or  one  serving  an  undeveloped  territory.  Out- 
standing bonds  must  bear  a  fixed  ratio  to  mileage, 
and  when  bonds  have  been  issued  at  a  rate  in  excess 
of  $20,000  per  mile,  care  should  be  exercised  in  their 
purchase.  The  value  of  bonds,  in  the  last  analysis, 
rests  upon  the  earning  power  of  the  railroad.  Prin- 
cipal and  interest  can  only  be  met  when  net  earn- 


LOANS   AND   INVESTMENTS        115 

ings  are  ample,  and  railroad  credit  vanishes  in  in- 
creasing ratio  as  net  earnings  decrease.  The  total 
annual  bond  interest  charge  of  a  railroad  should 
not  exceed  one-half  of  the  annual  net  earnings. 
When  net  earnings  are  not  in  proportion  of  two  to 
one  to  interest  charges  on  outstanding  bonds,  care 
should  be  exercised.  The  interest  charges  on  out- 
standing bonds  must  be  met  when  due  or  default 
occurs  and  foreclosure  follows.  Such  is  not  the 
case  with  dividends  on  capital  stock.  Dividends  are 
payable  only  when  earned  and  with  the  consent  of 
the  board  of  directors.  Dividends  are  not  usually 
fixed  charges  against  earnings.  Therefore  the  well 
financed  railroad  has  a  larger  amount  of  outstand- 
ing capital  stock  than  outstanding  bonds.  Con- 
servative financing  is  reaching  a  critical  point  when 
the  proportion  of  outstanding  bonds  to  capital  stock 
exceeds  one-half.  The  railroad  is  then  in  a  position 
where  it  is  compelled  to  pay  too  high  a  price  for  its 
money,  which,  if  long  continued,  weakens  its  re- 
sources and  causes  collapse.  In  estimating  the  se- 
security  of  railroad  bonds,  careful  study  should  be 
made  of  the  territory  served  by  the  road,  its  popu- 
lation, resources  and  capacity  for  development,  as 
well  as  of  its  past  history. 

105.  PUBLIC  UTILITY  BONDS.  —  Public 
utility  corporations  are  now  well  established,  and 
their  securities  are  considered  prime  investments. 
Recent  legislation  in  the  various  States  has  been 
favorable  to  the  stability  of  public  utility  enter- 


116        LOANS   AND   INVESTMENTS 

prises.     Public  utility  commissions  insure  steady 
earnings  and  prevent  reckless  and  disastrous  com- 
petition.    The  extension  of  the  use  of  electricity, 
gas  and  the  telephone,  is  in  its  infancy.     Public 
utility  earnings  have  shown  a  steady  increase,  and 
will  undoubtedly  continue  to  do  so  for  some  fur- 
ther period  of  time.    Bonds  issued  by  public  utility 
companies  are  approved  by  public  utility  commis- 
sions, and  in  most  States  can  only  be  issued  for  the 
actual  cost,  determined  by  investigation,  of  ttte 
property  upon  which  the  bonds  are  a  lien.    High 
grade  public  utility  bonds  bear  a  higher  rate  of 
interest,  and  usually  sell  at  a  lower  price,  than  rail- 
road bonds  of  equal  grade,  thus  insuring  a  larger 
interest  return.    Statistics  show  that  for  a  period 
of  years  public  utility  earnings  have  exhibited  a 
steady  increase  in  volume,  irrespective  of  prosperity 
or  depression.     Gas,  electricity  and  the  telephone 
are  no  longer  luxuries,  but  necessities,  and  with  in- 
creasing population  and  cheapness  of  service,  the 
public  utility  corporation  is  benefitting.     Electric 
street  and  interurban  railroads,  though  carriers  of 
passengers  and  freight,  are  usually  termed  public 
utility  corporations.     Their  condition  is  not  as  a 
rule  as  favorable  as  that  of  other  public  utilities,  on 
account  of  the  greater  expense  entailed  in  carrying 
on  their  functions,  and  because  they  are  in  most 
cases  subject  to  the  legislative  action  of  common 
councils  in  cities,  regarding  terms  of  franchise  and 
regulation  of  service.    In  some  States,  however,  the 


LOANS    AND    INVESTMENTS         117 

indeterminate  franchise,  practically  eliminating 
competition  and  placing  rate  making  under  the 
control  of  a  State  public  utility  commission,  has 
displaced  the  franchise,  to  the  benefit  of  the  cor- 
poration. The  investment  restrictions  applying  to 
the  bonds  of  public  utility  corporations  as  to  se- 
curity, proportion  of  net  earnings  to  interest 
charges,  ratio  of  capital  stock  to  bonded  debt,  out- 
standing bonds  per  mile  in  the  case  of  railways, 
territory  and  population  served,  are  similar  to  those 
applying  to  steam  railroads.  It  should  be  noted, 
however,  that  most  public  utility  corporations  oper- 
ate under  a  franchise  limited  as  to  time,  and  care 
should  be  taken  to  ascertain  that  the  franchise  does 
not  expire  during  the  life  of  the  outstanding  bonds. 
106.  INDUSTRIAL  BONDS.— With  the  great 
development  of  industrial  corporations  insuring,  as 
such  growth  does,  enlarging  fields  for  the  sale  of 
goods  and  their  manufacture  at  lowest  cost,  the 
command  of  inventive  genius  to  overcome  the  ad- 
vantages gained  by  the  inventions  of  others,  the 
control  of  the  production  of  raw  materials,  and 
diversity  of  output,  the  financing  of  their  credit 
needs  by  bond  issues  has  become  recognized  as  a 
conservative  method  of  finance.  Industrial  corpo- 
rations always  contend,  however,  with  different 
problems  than  do  most  other  forms  of  enterprise, 
and  in  a  large  measure  their  business,  although  a 
fundamental  one,  sometimes  involves  risks  ap- 
proaching the  classification  of  hazardous.  Bond 


118        LOANS    AND    INVESTMENTS 

issues  of  such  type  are  to  receive  different  consid- 
eration than  others.  Good  will  and  patent  rights 
must  be  carefully  considered.  A  going  plant  may 
have  large  cash  value,  but  the  salvage  worth  of  such 
a  plant  is  small.  If  the  management  is  not  pro- 
gressive, competition  may  soon  eliminate  its  goods 
from  the  market.  The  supply  of  raw  materials 
must  not  be  entirely  dependent  upon  the  good  will 
of  others,  nor  must  it  be  so  far  removed  from  the 
place  of  manufacture  as  to  work  a  disadvantage  in 
competition.  The  quick  assets  of  the  corporation 
must  be  carefully  investigated  and  analyzed,  and 
the  proportion  of  net  quick  assets  to  outstanding 
bonds  should  be  a  fixed  one,  and  always  maintained. 
Industrial  bonds  should  mature  at  an  early  period, 
and  should  have  a  sinking  fund  provision,  or  pre- 
ferably should  be  serial  in  maturity.  The  propor- 
tion of  net  earnings  to  interest  charges  should  be 
larger  than  in  the  case  of  railroads  and  public  utility 
corporations,  on  account  of  the  rapid  changes  which 
take  place  in  business  conditions.  A  first  mortgage 
bond  of  the  United  States  Steel  Corporation  is  un- 
doubtedly good,  but  it  cannot  be  placed  in  a  similar 
class  or  be  used  for  similar  investment  purposes,  as 
the  first  mortgage  bond  of  the  Pennsylvania  Rail- 
road Company. 

107.  EQUIPMENT  BONDS.— By  reason  of  an 
unusual  record  of  stability  and  safety,  continuously 
extending  over  a  long  period  of  years,  "equipment 
bonds"  or  "car  trusts"  deserve  consideration  as  in- 


LOANS  AND   INVESTMENTS        119 

vestments  of  the  highest  type.  Equipment  bonds 
issued  upon  the  security  of  rolling  stock,  including 
locomotives,  are  in  large  measure  preferred  liens 
upon  the  income  of  the  issuing  corporation,  for  a 
continuance  of  earnings  depends  upon  the  use  of 
rolling  stock,  and  a  default  in  equipment  bonds 
would  deprive  the  corporation  of  its  chief  means  of 
revenue.  In  times  of  receivership,  courts  have  or- 
dered the  payment  of  interest  and  principal  due 
upon  equipment  bonds,  in  preference  to  other  obli- 
gations, and  for  a  long  period  of  years  there  has 
been  no  default  in  equipment  obligations.  Equip- 
ment bonds  or  notes  are  issued  under  what  is  legally 
a  lease  or  an  agreement  of  conditional  sale.  These 
agreements  are  usually  recorded  in  the  States  ip 
which  the  corporation  operates,  and  are  not  can- 
celled until  payment  in  accordance  with  their  terms 
is  fully  made.  The  Philadelphia  plan  of  equipment 
trust  provides  for  the  creation  of  an  equipment 
trust  by  agreement  between  a  trust  company,  on£ 
or  more  designated  individuals,  and  the  corpora- 
tion. The  equipment  is  purchased  by  the  equip- 
ment trust  and  leased  by  the  trustee  to  the  corpora- 
tion, at  a  rental  sufficient  in  amount  to  meet  the 
principal  and  interest  of  the  equipment  bonds  or 
notes  when  due.  Such  bonds  or  notes  are  guaran- 
teed by  the  corporation. 

108.  TIMBER  BONDS.— The  issuance  of  "tim- 
ber bonds"  is  a  comparatively  recent  development 
in  finance.  A  great  amount  of  these  bonds  in  par 


120        LOANS   AND   INVESTMENTS 

value  has  been  absorbed  by  banks  and  the  investing 
public.  Timber,  standing,  and  of  good  quality,  is 
an  asset  which  as  time  passes  will  increase  in  value. 
Timber  as  security  for  a  bond  issue  has  been  likened 
to  land.  The  analogy  is  not  a  correct  one.  A  part 
is  never  equal  to  the  whole.  Land  is  a  fundamental 
value.  Timber  is  not.  Standing  timber  is  ordi- 
narily not  insurable.  The  fire  hazard  is  therefore 
of  first  importance.  Timber  bonds  have  usually 
been  issued  for  a  fixed  period  of  time  of  long  dura- 
tion. Provision  has  been  made  for  a  sinking  fund 
of  a  certain  percentage  in  money  of  the  amount  in 
feet  of  timber  cut.  Failure  to  provide  this  sinking 
fund  is  a  default  in  the  provisions  of  the  mortgage. 
To  prevent  such  default  timber  has  been  cut  when 
the  market  was  so  low  in  price  as  to  cause  inevitable 
loss.  Such  loss  exhausted  the  resources  of  the  com- 
pany obligated  on  the  bonds,  and  in  some  cases  re- 
sulted in  receivership.  The  sinking  fund  in  timber 
bond  issues  is  not  sound,  and  should  be  displaced 
by  the  serial  bond  issue.  The  timber  business  is 
not  a  stable  one,  and  timber  bonds  are  oftentimes 
classed  as  hazardous  investments.  The  rate  of  in- 
terest paid  on  such  bonds  would  seem  to  indicate 
that  they  are  so  considered.  In  many  timber  bond 
issues  the  security  of  the  issue  consists  largely  of 
other  assets  than  standing  timber,  such  as  saw 
mills,  pulp  mills  and  paper  mills.  The  bonds  may 
also  bear  an  endorsement  worth  considerably  in 
excess  of  the  debt  guaranteed. 


LOANS   AND    INVESTMENTS         121 

109.  DRAINAGE     AND     RECLAMATION 
BONDS. — For  the  purpose  of  reclaiming  fertile 
land  a  large  part  of  the  time  under  water,  political 
subdivisions  designated  as  "drainage  districts"  have 
been  created  under  constitutional  authority,  with 
power  to  issue  bonds  and  to  assess  and  levy  taxes 
against  real  property  for  their  payment,  together 
with  the  interest  thereon  accrued.  Various  methods 
are  used  in  carrying  out  this  purpose  and  in  provid- 
ing for  tax  levies.    In  some  districts  taxes  are  levied 
by  county  authorities,  in  others  by  judicial  officers. 
This  type  of  bond  often  is  little  more  than  a  special 
assessment  bond  against  benefitted  property,  and 
its  ultimate  payment  is  secured  by  the  value  of  the 
property,  and  not  by  a  general  tax  levy.    "Reclam- 
ation bonds"  are  similar  in  purpose  and  form,  and 
are  issued  for  the  redemption  of  arid  lands,  through 
the  use  of  water.    Where  municipal  districts  are 
created  for  this  purpose  they  are  similar  to  drainage 
districts  in  form  and  powers  granted.  Corporations 
have  endeavored  to  reclaim  arid  lands  through 
funds  provided  by  bond  issues,  but  the  problems 
involved  have   been   so  intricate   and   vast  that 
disaster  in  most  instances  has  been  the  result. 

110.  LAND  MORTGAGE  BONDS.— A  type 
of  bond  which  will  ultimately  become  more  gener- 
ally utilized  is  the  "land  mortgage  bond"  issued  by 
land  banks  under  State  authority,  or  by  the  various 
associations  created  under  the  Rural  Credits  Act. 
The  distinctive  features  of  these  classes  of  bonds  are 


122        LOANS   AND    INVESTMENTS          ^ 

long  existence  before  maturity,  amortization  plan 
of  repayment,  exemption  from  taxation,  and  legal 
investment  for  fiduciary  and  trust  funds. 

111.  BOND  ISSUANCE.— Bonds  have  been 
described  as  a  species  of  promissory  note,  being 
a  promise  to  pay  a  certain  sum  at  a  definite  time 
with  interest  at  a  fixed  rate.  The  main  distinc- 
tions between  bonds  and  promissory  notes  have 
to  do  largely  with  proportions.  The  maker  of  a 
promissory  note,  the  promisor,  may  be  an  indi- 
vidual, a  partnership  or  at  times  a  corporation. 
The  maker  of  a  bond,  or  the  obligor,  is  a  govern- 
ment, a  State  or  municipality,  or  a  corporation; 
seldom  an  individual.  The  amount  of  the  promis- 
sory note,  limited  largely  by  the  loaning  capacity 
of  a  bank,  is  usually  less  than  one  hundred  thou- 
sand dollars.  The  amount  of  a  bond  issue  is 
usually  a  matter  of  millions,  split  up  into  segments 
that  it  may  be  absorbed  by  the  investing  public. 
The  promissory  note  is  for  a  period  of  months, 
the  bond  is  due  after  a  period  of  decades.  It  will 
be  of  interest  to  trace  briefly  the  process  in  finance 
through  which  bonds  are  issued,  taking  for  an 
example  the  bonds  of  a  large  corporation  making 
steel  rails. 

112.  PROCEDURE  IN  ISSUING  BONDS.— 
There  would  probably  be  three  or  four  plants  of 
such  a  company  in  operation,  each  located  con- 
veniently near  its  supply  of  fuel  and  raw  products. 
In  the  course  of  time,  owing  to  the  development 


LOANS   AND   INVESTMENTS        123 

of  a  certain  section  of  the  country,  conditions 
might  arise  that  would  put  the  business  of  one, 
of  these  plants  on  a  much  more  profitable  basis  if 
it  could  increase  its  share  of  the  output,  a  result; 
only  to  be  attained  through  the  erection  of  several 
new  buildings  and  the  installation  of  costly  ma- 
chinery. To  do  this  would  require  at  least  $2,500,- 
000.  The  company,  therefore,  decides  to  issue  that 
amount  in  bonds  secured  by  a  first  mortgage  on 
another  part  of  the  property.  A  special  meeting 
of  the  stockholders  is  held  and  the  whole  matter 
is  laid  before  them.  A  large  majority  of  the  stock- 
holders, having  full  confidence  in  the  officers  of 
the  corporation,  will,  of  course,  send  their  proxies, 
so  that  the  meeting,  perhaps,  will  be  but  little 
larger  than  an  ordinary  directors'  meeting.  At 
that  time  it  is  decided  how  long  the  bonds  shall 
run,  what  the  rate  ought  to  be,  and  what  particular 
part  of  the  property  shall  be  mortgaged  as  se- 
curity for  the  issue.  It  will  be  shown  that  although 
the  interest  on  the  new  bonds  will  add  to  the  fixed 
expenses,  yet  the  increased  manufacturing  facili- 
ties will  largely  add  to  the  profits  and  perhaps 
reduce  very  materially  the  amount  of  money  which 
must  be  borrowed  from  time  to  time  on  short- 
term  notes. 

113.  BOND  UNDERWRITING  SYNDI- 
CATES.—The  next  step  is  to  find  a  banking 
house  that  will  offer  the  best  price  for  the  entire 
issue,  that  is,  advance  the  money  to  the  corpora- 


124        LOANS   AND   INVESTMENTS 

tion,  or  "underwrite"  the  bonds.  A  price  is  finally 
agreed  upon  and  the  bankers  take  over  the  issue, 
say  at  90 ;  that  is,  they  advance  to  the  corporation 
$2,250,000.  In  the  meantime,  a  trust  company  has 
agreed  to  act  as  trustee  of  the  mortgage  securing 
the  bonds,  receiving  a  fee  in  payment  for  the  ser- 
vice, and  also  probably  being  appointed  as  a  deposi- 
tory for  the  payment  of  the  interest  on  the  bonds 
as  it  falls  due.  A  registrar  will  also  have  been 
appointed. 

114.  BOND     SELLING     SYNDICATES.— 
Having  received  the  issue  of  bonds  and  advanced 
the  money  to  the  corporation,  the  banking  house 
will  now  undertake  to  dispose  of  them  at  a  fair 
profit,  not,  however,  directly  to  the  public.    A  syn- 
dicate will  be  formed  among  several  banking  and 
bond  houses,  each  of  which  will  take  an  allotment 
at  a  certain  price.    These,  in  turn,  act  as  distrib- 
uting agents  and  through  their  salesmen  and  letters 
to  regular  clients  the  issue  is  finally  taken  up  by  the 
public.     In  buying  the  bonds,  the  ultimate  pur- 
chasers are  largely  influenced  by  the  reputation  of 
the  banking  firm,  since  the  bank's  position  is  in 
the  nature  of  an  intermediary  between  the  corpora- 
tion and  the  public.     The  net  result  is  that  the 
corporation  has  borrowed  from  the  general  public 
in  small  lots  the  sum  of  money  needed  for  its 
purposes. 

115.  STOCK    EXCHANGES.  — Many  of  the 
larger  cities  in  all  countries  have  found  it  necessary 


LOANS   AND    INVESTMENTS        12S 

to  organize  stock  exchanges  for  the  purpose  of 
facilitating  the  buying  and  selling  of  the  enormous 
quantity  of  corporate  stocks  and  bonds  which  now 
exist.  These  exchanges  are  but  the  evolution  of 
a  common  meeting  place,  such  as  the  old  coffee 
kouses,  bank  corridors,  or  certain  street  corners, 
where  it  originally  was  the  custom  of  those  who 
dealt  in  government  or  other  securities  to  congre- 
gate. A  survivor  of  the  old  stock  exchange  locali- 
ties is  the  modern  "curb  market"  where  are  sold, 
in  the  open  air,  those  stocks  and  bonds  which  have 
not  been  listed  on  any  regular  exchange.  The  curb 
market  in  New  York  City,  which  has  been  in  exist- 
ence for  more  than  thirty  years,  is  probably  the 
most  important  one  of  its  kind  in  the  United  States. 
Its  operations  are  conducted  in  Broad  street. 

116.  SERVICE  OF  STOCK  EXCHANGES.— 
The  Stock  Exchange  gives  to  good  stocks  and 
bonds  a  ready  market  and  a  known  price.  Without 
these  two  features,  bonds  would  lose  their  value 
entirely  as  a  temporary  investment  for  the  idle 
funds  of  a  bank.  It  is  the  ease  with  which  they 
may  be  converted  into  cash  that  makes  bonds  use- 
ful as  "secondary  reserve."  Stock  Exchange  prices 
go  over  the  "ticker"  and  are  published  in  the  news- 
papers in  every  town  of  importance  in  the  world. 
Thus  it  is  possible  to  keen  in  touch  with  the  market 
value  of  securities  far  from  the  centres  in  which 
they  are  dealt,  and  the  radius  of  their  usefulness  as 
collateral  for  bank  loans  is  greatly  widened.  Since 


126        LOANS   AND    INVESTMENTS 

stocks  in  financial  institutions  are  not  as  a  rule 
traded  in  very  generally  on  any  of  the  great  stock 
exchanges,  this  class  of  stocks  does  not  figure  as 
prominently  in  the  daily  quotations  as  do  railroads 
and  industrials.  Nevertheless,  the  total  of  bank 
stocks  in  the  United  States  compares  very  favor- 
ably with  the  totals  of  the  other  kinds.  And  in 
spite  of  the  fact  that  the  personal  element  enters 
into  a  consideration  of  bank  stocks  probably  more 
than  in  any  other,  it  must  be  admitted  that,  judged 
by  the  ordinary  elements  of  strength,  these  are 
quite  as  attractive  as  any  other  kind.  The  ease 
which  the  Stock  Exchange  affords  for  the  purchase 
and  sale  of  securities  which,  on  account  of  economic 
causes,  are  subject  to  fluctuations,  has  made  it  a 
centre  for  speculation  as  well  as  investment.  Au- 
thorities find  it  hard  to  agree  as  to  what  extent 
these  two  terms  may  or  may  not  be  synonymous. 
117.  GOVERNMENT  OF  STOCK  EX- 
CHANGES.—The  government  of  the  Exchange 
is  vested  in  a  committee,  consisting  of  a  president 
and  other  officers,  together  with  a  number  of  mem- 
bers. This  governing  committee  has  power  to 
draft  rules  for  the  conduct  of  business  and  is  the 
administrative  body.  In  addition,  there  may  be 
several  other  committees,  for  example  the  commit- 
tee on  stock  list,  which,  after  investigation  along 
prescribed  lines,  has  authority  to  list  stocks  on  the 
Exchange.  The  members  of  the  Exchange  have 
"seats,"  which  term  means  the  privilege  to  con- 


LOANS   AND   INVESTMENTS        127 

duct  business  on  the  "floor."  This  is  the  large 
open  space  where  the  brokers  congregate.  At  in- 
tervals are  posts  which  designate  the  particular 
stock  which  may  be  bought  or  sold  there.  This 
system  is  one  of  wheels  within  a  wheel  and  makes 
it  unnecessary  for  a  broker  to  search  about  the 
room  for  a  purchaser  when  he  wishes  to  sell  or  buy 
a  certain  stock.  Sales  are  made  practically  at  auc- 
tion; that  is,  the  seller  asking  for  a  price  and  the 
buyers  bidding  usually  a  little  below.  As  sales  are 
effected,  memorandum  notes  are  made  by  both 
parties,  which  are  checked  up  at  the  end  of  the 
day.  In  the  larger  stock  exchanges,  settlement  is 
made  through  the  stock  exchange  clearing  house 
for  the  more  active  stocks.  This  mechanism  oper- 
ates similarly  to  the  ordinary  bank  clearing  house 
for  the  exchange  of  checks.  Well-known  active 
stocks  are  usually  listed  on  several  stock  exchanges 
and  this  fact  has  led  to  what  is  known  as  the  "arbi- 
trage" business,  that  is,  the  purchase  of  stocks  in 
one  city,  London,  for  example,  where  for  some  local 
reason  prices  may  be  low,  the  stocks  being  then 
resold  at  a  higher  price  in  New  York. 

118.  FINANCIAL  TERMS.— There  are  many 
terms  common  to  stock  exchanges,  a  few  of  which, 
although  in  everyday  use,  are  not  generally  under- 
stood by  the  public.  Such  are  the  following: 

"Bear" — One  who  is  interested  in  having  the 
prices  of  one  or  more  securities  decline. 

"Bull" — One  who  wants  prices  to  advance. 


128        LOANS   AND    INVESTMENTS 

When  a  broker  has  bought  more  of  a  certain 
stock  than  he  has  contracts  to  deliver,  he  is  said 
to  be  "long"  of  that  stock.  Selling  "short"  means 
selling,  or  contracting  to  deliver,  stock  that  the 
broker  does  not  own.  A  "short  interest"  is  a  group 
that  expects  to  buy  stocks  after  a  fall  in  prices. 
If  instead  prices  have  advances,  such  brokers  incur 
a  loss. 

Another  expression  in  common  use,  but  not 
clearly  understood,  is  the  term  "watered  stock." 
Such  stock  is,  of  course,  in  disrepute,  and  means 
that  a  larger  issue  of  stock  has  been  sold  to  in- 
vestors than  is  represented  by  the  actual  value  of 
corporate  property.  This  is  not  to  be  confused 
with  over-capitalization,  which  means  a  larger 
capital  has  been  subscribed  than  is  necessary  to 
conduct  the  business  on  an  interest  or  dividend 
paying  basis. 

119.  BANKS  AND  STOCK  EXCHANGES.— 
For  the  purpose  of  buying  and  selling  stocks  and 
bonds,  the  broker  requires  a  vast  amount  of  money, 
since  the  purchaser  may  not  settle  until  the  securi- 
ties are  actually  delivered  or  transferred.  This 
money  is  advanced  by  the  banks  on  collateral  by] 
what  is  known  as  "call"  or  "demand"  loans.  The 
bank  is  privileged  to  ask  payment  for  such  loans 
on  short  notice,  although  custom  has  decreed  that 
a  sufficient  time  must  be  given  the  borrower  to 
make  a  readjustment.  Demand  loans  sometimes 
run  for  long  periods  of  time,  the  interest  being 


LOANS    AND    INVESTMENTS        129 

paid  at  certain  intervals  at  varying  rates.  While 
the  call  money  market  may  be  said  to  bring  the 
banks  in  closer  touch  with  the  speculative  element 
of  the  stock  exchange  than  may  be  best,  yet  is  un- 
doubtedly an  excellent  medium  through  which  the 
inflexibility  of  reserve  requirements  may  be  ad- 
justed. For  example,  a  large  part  of  the  surplus 
funds  of  all  the  banks  in  the  United  States  has  a 
tendency  to  gravitate  to  New  York.  It  is  the  stock 
market  which  creates  a  demand  for  this  money 
and  it  is  mostly  all  absorbed  by  the  brokers  on 
call  loans. 

120.  BONDS  AS  INVESTMENTS.— As  has 
been  stated,  many  banks  now  conduct  a  separate 
department,  the  function  of  which  is  to  pro- 
vide proper  facilities  and  advice  for  their  customers 
in  the  purchase  of  bonds.  Such  departments  are 
under  the  supervision  of  experts  who  are  specialists 
on  bond  issues  and  values.  The  average  investor 
has  neither  the  capacity,  experience  nor  time  for 
study  to  enable  him  to  make  a  wise  choice  in  the 
purchase  of  bonds.  Against  fake  investment 
schemes  and  wild  cat  bond  issues,  State  laws  have 
been  proposed,  such  as  the  pioneer  "blue  sky  law" 
of  Kansas.  This  law  requires  every  investment 
company,  whether  organized  under  the  laws  of  the 
State  of  Kansas  or  any  other  State,  to  file  in  the 
office  of  the  State  Bank  Commissioner  a  statement 
showing  in  full  detail  the  plan  upon  which  it  pro- 
poses to  transact  business,  a  copy  of  all  contracts. 


130        LOANS   AND    INVESTMENTS 

bonds  or  other  investments  which  it  proposes  to 
make  with  or  sell  to  its  contributors,  also  a  state- 
ment showing  the  name  and  location  of  the  invest- 
ment company,  and  an  itemized  account  of  its 
actual  financial  condition,  with  the  amount  of  its 
property  and  the  amount  of  its  liabilities,  and  such 
other  information  as  may  be  required.  If  condi- 
tions are  found  to  be  satisfactory,  the  Bank  Com- 
missioner, in  whom  complete  judicial  authority 
rests,  will  then  issue  a  license  for  the  vending  com- 
pany and  its  agents  to  do  business  in  the  State. 
Certain  institutions  and  certain  securities  are  ex- 
empt from  the  provisions  of  the  statute,  viz. :  State 
and  National  banks,  trust  companies,  real  estate 
mortgage  companies  dealing  in  real  estate  mort- 
gage notes,  building  and  loan  associations,  and  cor- 
porations not  organized  for  profit.  The  securities 
excepted  are  bonds  of  the  United  States,  State  of 
Kansas,  or  some  municipality  of  the  State  of  Kan- 
sas, and  notes  secured  by  mortgage  on  property  in 
the  State  of  Kansas.  The  interests  of  the  pro- 
spective investor  are  thus  safeguarded  by  expert 
advice  and  legislative  statute. 

121.  ELEMENTS  OF  SECURITY.— The  ele- 
ments of  security  in  stocks  and  bonds  have  been 
tersely  formulated  by  Rufus  Waples  of  Philadel- 
phia in  the  following  rules: 

(1)  Minimum  liability  of  loss  is  secured  in  the 
class  of  bonds  authorized  for  the  investment  of 
trust  funds  by  such  a  State  as  New  York. 


LOANS    AND    INVESTMENTS        131 

(2)  No  reasonable  likelihood  of  loss  is  incurred 
in  buying  bonds  that  are  legally  issued  and  are  3 
valid  and  binding  obligation  on  all  the  taxable 
property  of  a  city  of  over  10,000  population,  when 
it  is  a  long  settled  community  and  has  many  di- 
versified sources  of  revenue,  with  a  debt  of  about 
5%  of  the  assessed  valuation  or  less.    Smaller  cities 
are  more  apt  to  be  negligent  at  times  in  paying 
obligations  at  the  date  due. 

(3)  There  is  a  very   strong  presumption  of 
safety  in  bonds  of  dividend  paying  transportation 
companies  enjoying  right  of  eminent  domain  and 
on  those  of  public  utility  corporations  (railroads, 
street  railways,  gas,  water  works,  etc.),  when  satis- 
factory earnings  have  been  maintained  for  several 
years;    when  the  amount  of  bonds  authorized  is 
properly  limited;    when  charter  and  franchise  or 
physical  or  other  conditions  offer  a  large  measure 
of  protection  from  competition;    and  when  the 
franchise  will  survive  the  maturity  of  the  bonds 
for  a  satisfactory  period. 

(4)  There  is  a  fair  presumption  that  interest 
on  an  industrial  bond  will  be  earned  and  bond  paid 
at  maturity,  if  the  permanent,  available  assets  (land 
and  buildings  of  a  general  character  and  property 
that  cannot  be  diverted  or  seriously  depreciated) 
offer  foreclosure  value  sufficiently  in  excess  both  of 
the  bond  issue  and  of  all  practicable  depreciation, 
and  if  the  surplus  earnings  provide  an  adequate 
sinking  fund  for  the  retirement  of  bonds. 


132        LOANS   AND   INVESTMENTS 

(5)  The  probabilities   strongly  favor   regular 
dividends  on  a  conservative  issue  of  preferred  stock 
when  a  much  larger  issue  of  common  stock  has 
long  earned  dividends  and  surplus,  and  when  com- 
mercial fluctuations  cannot  seriously  unsettle  the 
average  net  business  profit. 

(6)  There  is  a  good  business  chance  that  com- 
mon stock  will  maintain  the  average  earnings  of 
the  past  ten  years  if  the  business  is  essentially  of 
a  permanent  nature ;  and  if  the  managers  who  built 
up  the  business  are  in  the  prime  of  life,  and  have 
accumulated  large  resources  as  surplus  earnings  of 
said  business;   and  if  they  retain  both  the  active 
management  and  their  own  interest  in  the  business. 

122.  TEST  QUESTIONS.— An  investor,  when 
offered  full  information  about  a  security  that  is 
new  to  him,  and  that  does  not  at  once  command 
his  confidence,  wishing  to  know  the  favorable 
features,  and  to  discover  the  points  of  danger,  can, 
with  a  little  patience,  act  understandingly  by  apply- 
ing certain  well-established  principles,  taught  by 
the  history  of  securities,  and  conveniently  made 
use  of  as  test  questions. 

(1)  Was  the  bond  prepared  by  the  best  legal 
talent,  at  the  instance  of  experienced  bankers,  with 
the  single  purpose  of  affording  the  greatest  protec- 
tion possible  to  the  bondholders? 

(2)  Were  all  steps  taken  under  honest,  capable 
experts  (business,  legal,  engineering  and  account- 
ing), and  are  the  records  available  for  examination? 


LOANS    AND    INVESTMENTS        133 

(3)  Is  the  capitalization  conservative?    Has  the 
cash  cost  or  probable  physical  and  franchise  value 
been  closely  approached  or  exceeded  in  the  author- 
ized bond  issue? 

(4)  Is  the  security  issued  by  a  company  that 
furnishes    all    reasonable    information    to    stock- 
holders about  its  earnings  and  condition? 

(5)  If  the  security  is  issued  by  a  company  that 
should  prosper  greatly  by  increasing  population,  is 
the   company's   property   so   situated   that   local 
growth  in  any  portion  of  its  territory  will  benefit  it? 

(6)  Are  the  bonds  and  stock  owned  in  good 
part  by  men  of  financial  strength  whose  self-interest 
would  lead  them  at  all  times  to  consider  the  welfare 
of  the  company? 

(7)  If  foreclosure  became  necessary,  would  a 
creditor  or  bondholder  be  satisfied  to  become  part 
proprietor  or  property  owner,  on  account  of  the 
great  value  of  the  pledged  property? 

(8)  Has  the  management  ably,  conservatively 
and  conscientiously  worked  out  developments  for 
the  good  of  the  company? 

(9)  Are  the  employees  contented,  amenable  to 
discipline   and   working   harmoniously   with   the 
management? 

(10)  Has  the  earning  power  back  of  this  se- 
curity a  broad  dependence  upon  the  patronage  of 
many  customers  well  able  to  pay  for  service  or 
goods? 

(11)  Is  the  earning  power  of  the  company 


134        LOANS    AND    INVESTMENTS 

fairly  well  protected  from  injurious  competition 
and  likely  to  continue  so,  with  a  growing  popula- 
tion to  serve  or  trade  to  rely  upon? 

(12)  Is  the  earning  power  of  the  company  de- 
pendent  upon   the   patronage   of  hoped-for   cus- 
tomers, or  upon  sub-companies  organized  to  supply 
a  demand?     Does  it  seem  likely  that  profits  are 
only  a  future  matter — to  be  reached  in  "process 
of  time." 

(13)  Does  the  earning  power  depend  upon  any 
expectation  of  unfair  advantage  over  competitors, 
such  as  reliance  on  a  degree  of  official  favoritism 
that   seems   attractive  to  some   men,   though  it 
cannot  permanently  aid  a  true  investment  bond  or 
stock? 

(14)  Are  the  conditions  of  earning  power  grow- 
ing   unfavorable    from    (a)    Insufficient    capital? 
(b)  Increasing  cost  of  operation?     (c)  Increasing 
demands  of  employees,  or  strikes?     (d)  Substitu- 
tion by  competitors  of  new  methods  or  materials 
for  old?     (e)  Depletion  of  products  of  mines  or 
quarries?     (f)  Depletion  of  products  of  forests? 
(g)  Depletion  of  products  of  agriculture?    (h)  Loss 
of  population?     (i)  Increasing  cost  of  service  or 
distance  of  deliveries?     (j)  Increasing  cost  of  se- 
curing raw  materials  or  fuel?    (k)  Obsolete  equip- 
ment or  superior  equipment  of  business  competi- 
tors?   (1)  Loss  of  tariff  advantage?     (m)  Loss  of 
skill  or  prestige  in  management?    (n)  New  or  im- 
proved or  shorter  competing  railway  lines?     (o) 


LOANS   AND    INVESTMENTS        135 

Larger  tonnage  in  competing  steamship  lines?    (p) 
New  rival  methods  of  doing  business? 

(15)  Is  the  price  asked  for  the  bond  or  stock 
much  greater  or  less  than  the  usual  quotation? 

(16)  Has  the  security  been  quoted  higher  or 
lower  in  price  because  of  some  influence  afterward 
withdrawn?     (Learn  if  there  have  been  purchases 
by  a  sinking  fund,  expectation  that  the  issue  would 
be  bought  in  and  retired,  accumulation  in  view  of 
acquiring  voting  control,  or  supposed  important 
advantage  or  disadvantage  from  new  connections, 
discoveries,  trade  expansion  or  loss,  etc.,  and  learn 
exact  facts.) 

(17)  Is  the  bond  offered  presented  as  a  bar- 
gain, at  such  a  price,  or  with  such  prospects  of 
peculiar  advantage  to  buyer  as  to  disorganize  the 
investor's  critical  faculty  and  hasten  him  into  a 
purchase  in  the  belief  that  he  is  securing  great 
value  for  much  less  than  it  is  worth? 

(18)  Are  the  bond  buyer  and  his  associates  fur- 
nishing money  for  experiments  to  get  5%  if  a  new 
enterprise  prospers  and  take  all  the  loss  if  it  fails? 

(19)  Is  the  bond  issue  large  enough  to  secure 
the  best  legal  talent,  if  it  should  be  needed  to  pro- 
tect the  issue,  by  levying  a  small  percentage  upon 
each  bond? 

(20)  Are  the  business  affairs  of  the  company 
conducted  on  such  a  scale  that  a  judgment  for 
injury  or  loss  of  life  would  probably  be  but  a  small 
percentage  of  the  net  earnings  of  the  company? 


136        LOANS    AND    INVESTMENTS 

(21)  Is  the  bond  issue  so  large,  or  complicated, 
or   difficult   to   understand,   that   sales   of   timid 
holders  would  be  likely  to  cause  great  price  fluctu- 
ations? 

(22)  Is  the  vendor  of  the  security  a"ble,  in  behalf 
of  the  bond  or  stock  offered,  to  give  satisfactory 
replies  to  all  questions  above  cited  that  properly 
apply  to  it? 

(23)  Is  the  vendor,  through  responsibility  and 
ample  experience,  an  authority  for  all  statements 
made  by  him? 

(24)  Have   responsible    bankers    directed    the 
initial  and  all  later  steps  taken  in  preparation  of  this 
security,  bringing  an  experienced,  judicial,  business 
training  to  bear  upon  the  fullest  information,  ob- 
tained by  the  most  capable  experts  available? 


CHAPTER  IV 

Collateral  Loans 

123.     PLEDGE    OR    HYPOTHECATION.— 

"Collateral  loans"  are  loans  secured  by  pledge  of 
personal  property.  A  pledge  is  a  bailment  of  per- 
sonal property  as  security  for  the  payment  of  a 
debt  or  the  performance  of  an  act,  with  an  option 
of  sale  in  the  pledgee  upon  the  default  of  the 
pledger  in  his  engagement.  The  article  pledged 
may  be  any  species  of  personal  property,  but  of  late 
years  a  pledging  of  stocks,  bonds,  negotiable  paper 
and  other  representatives  of  intangible  personal 
property  has  come  to  be  designated  by  the  term 
"hypothecation,"  or  the  giving  of  "collateral  se- 
curity," to  distinguish  such  a  pledge  from  a  pledge 
of  material  articles.  A  pledge  gives  greater  rights 
than  a  lien,  for  a  pledgee  has  a  power  of  sale  which 
the  owner  of  a  lien  has  not.  It  is  less  than  a  chattel 
mortgage,  for  in  a  chattel  mortgage  the  legal  title 
passes,  subject  to  be  divested  upon  the  fulfillment 
of  the  mortgage  terms;  in  a  pledge  the  title  may  or 
may  not  pass— ordinarily  it  does  not,  but  it  has 
been  held  that  it  does  in  collateral  securities.  It 
differs  further  from  a  chattel  mortgage  in  that  to 
create  a  pledge  no  writing  that  it  is  a  debt  and  a 
surrender  of  possession  of  property  is  necessary, 
and  it  is  required  merely  that  there  be  property  as 
security.  Ordinarily,  too,  a  chattel  mortgage  must 

137 


138        LOANS   AND    INVESTMENTS 

be  recorded  to  be  effective  against  third  parties, 
while  a  pledge  need  not  be. 

124.    FORMATION     BY     CONTRACT.  — A 
pledge  is  created  by  contract,  either  express  or 
implied.    An  assignment  of  securities  by  a  debtor 
to  a  creditor  is  presumed  to  be  a  pledge  rather  than 
a  payment,  and  where  doubt  exists  whether  the 
transaction  is  a  pledge  or  a  chattel  mortgage  the 
courts  favor  holding  it  a  pledge.     The  aim  is  to 
determine  the  real  intention  of  the  parties,  and 
classify  the  transaction  according  to  the  intention 
shown.    There  must  be  a  debt  or  engagement  to 
be  secured  in  order  to  create  a  pledge,  but  this  debt 
may  be  some  other  person's  than  the  pledger's, 
and  a  pledge  may  be  made  to  secure  a  present, 
future  or  past  debt,  though  to  make  a  valid  pledge 
for  a  past  debt  some  new  consideration  is  ordin- 
arily required.    The  pledge  may  be  made  to  cover 
new  debts  as  they  arise,  but  there  must  be  an 
agreement  between  the  parties  to  effect  this,  for 
the  pledge  will  not  be  deemed  to  attach  to  the  new 
debt  unless  the  new  loan  was  made  upon  the  se- 
curity of  the  pledge.    So  the  existence  of  a  former 
debt  gives  the  pledgee  no  right  to  hold  the  pledge 
when  the  debt  to  secure  which  it  was  given  has 
been  paid.    If  the  debt  or  contract  to  secure  which 
the  pledge  is  given  is  illegal,  the  pledgee  can- 
not of  course  recover  upon  the  contract,  but  he 
may   nevertheless   retain  the   pledge   until   it  is 
redeemed. 


LOANS    AND    INVESTMENTS         139 

125.  WHAT   MAY   BE   PLEDGED.  —  Prac- 
tically any  personal  property,  tangible  or  intangi- 
ble, may  be  pledged,  as  the  right  to  shares  of  stock 
in  a  corporation.    Even  property  exempt  from  exe- 
cution on  a  judgment,  as  a  mechanic's  tools,  or 
necessaries,  may  be  pledged.    Property  not  yet  in 
existence  cannot  be  pledged,  and  the  attempt  to  do 
so  merely  creates  a  contract  to  make  a  pledge  in 
the  future,  like  an  agreement  to  sell.    Pay  of  soldiers 
and  pensions  cannot  be  pledged.    By  the  National 
Bank  Act  it  is  provided  that  "No  association  shall 
make  any  loan  or  discount  on  the  security  of  the 
shares  of  its  own  capital  stock,  nor  be  the  purchaser 
or  holder  of  any  such  shares,  unless  such  security 
or  purchase  shall  be  necessary  to  prevent  loss  upon 
a  debt  previously  contracted  in  good  faith,  and 
stock  so  purchased  or  acquired,  shall,  within  six 
months  from  the  time  of  its  purchase,  be  sold  or 
disposed  of  at  public  or  private  sale." 

126.  PARTIES  AND  TITLE.— A  person  who 
transfers  personal  property  in  pledge  as  security 
for  a  debt  must  own  the  property  or  at  least  have 
apparent  authority  to  pledge  it.    One  who  has  been 
voluntarily  clothed  by  the  owner  with  the  indicia 
of  ownership,  though  this  may  have  been  induced 
by  fraudulent  representation,  may  make  a  valid 
pledge  as  against  the  owner.    One  who  takes  nego- 
tiable instruments  in  pledge  before  maturity  in  good 
faith  for  value  and  without  notice  of  any  defect 
in  the  pledger's  title,  acquires  a  valid  holding  title. 


140        LOANS    AND    INVESTMENTS 

Except  in  these  two  cases  the  pledgee  acquires  no 
greater  title  than  the  pledgor  had.  Mere  possession 
of  chattels,  by  whatever  means  acquired,  if  there 
be  no  other  evidence  of  property  or  authority  to 
sell  from  the  true  owner,  will  not  enable  the  pos- 
sessor to  give  good  title.  An  agent  may  pledge 
when  and  as  his  principal  holds  him  out  as  having 
authority;  if  an  agent  pledges  goods  of  his  prin- 
cipal to  secure  his  private  debt,  the  principal  is 
entitled  to  recover  them  from  the  person  to  whom 
they  are  pledged,  unless  the  agent  was  invested  with 
the  indicia  of  ownership,  or  the  pledge  was  of  ne- 
gotiable securities.  In  most  States,  by  statute  en- 
actment, factors  (commission  merchants)  may 
pledge  goods  entrusted  to  them  to  sell.  One  mem- 
ber of  a  partnership  may  make  a  valid  pledge  of 
firm  property  to  secure  a  partnership  debt,  but  not 
to  secure  an  individual  debt.  An  executor,  admin- 
istrator, trustee  or  other  person  in  a  representative 
capacity  may  not  pledge  his  trust  property  for  his 
own  benefit.  One  who  has  only  a  lien  cannot  make 
a  valid  pledge,  because  to  maintain  a  lien  he  must 
retain  possession,  while  a  pledge  requires  a  delivery. 
Buying  stocks  on  a  margin  creates  the  relation  of 
pledgee  and  pledgor  between  the  broker  and  his 
customer. 

127.  DELIVERY.— An  absolute  essential  to  the 
creation  of  a  pledge  is  a  delivery,  actual  or  construc- 
tive, of  the  property  pledged.  A  constructive  delivery 
occurs  when  the  evidence  of  recognized  symbols  of 


LOANS    AND    INVESTMENTS         141 

the  thing  is  delivered,  as  the  delivery  of  a  ware- 
house receipt,  or  a  bill  of  lading.  But  there  must 
be  some  delivery.  Thus  where  a  bank  cashier,  to 
secure  a  creditor,  sealed  up  a  package  of  bank  notes 
with  an  endorsement  of  their  purpose  and  placed 
them  in  the  bank  vault,  it  was  held  that  the  creditor 
had  no  pledge  or  lien.  A  delivery  to  a  third  party 
for  the  pledger's  benefit  with  his  consent  is  suf- 
ficient. A  delivery  with  an  intention  to  create  a 
pledge  is  sufficient  to  create  the  relation  of  pledgor 
and  pledgee  without  writing  or  other  act,  but  not 
in  the  case  of  certificates  of  stock,  where  a  writing 
is  required  unless  the  certificate  has  been  endorsed 
in  blank.  Even  where  a  note  is  payable  to  a  person's 
order  there  may  be  a  valid  pledge  of  it  without  en- 
dorsement, though  the  practice  is  not  to  be  recom- 
mended. But  in  the  case  of  stock  it  is  necessary 
that  there  be  a  written  transfer  or  power  of  attorney 
of  some  kind.  The  pledge  continues  so  long  as 
the  pledgee  retains  possession,  and  the  pledgee 
has  a  right  against  all  the  world  to  the  retention  of 
the  article  pledged  until  the  payment  of  the  debt 
secured,  except  as  against  the  holder  of  a  right 
which  attached  to  the  property  before  the  making 
of  the  pledge.  But  a  pledge  of  collateral  securities 
may  be  temporarily  redelivered  to  the  pledgee  for 
the  purpose  of  collection  by  the  pledgor  without 
affecting  the  pledgee's  lien,  though  this  exception 
is  not  favored  and  is  strictly  limited. 

128,     RIGHTS    AND    LIABILITIES    OF 


142        LOANS    AND    INVESTMENTS 

PLEDGOR. — A  pledger  has  a  right  to  assign,  by 
sale  or  otherwise,  his  reversionary  interest  in  the 
pledge,  and  upon  notice  to  the  pledgee  the  latter 
will  be  bound  upon  payment  of  the  debt  secured  to 
turn  the  pledge  over  to  the  assignee.  He  has  also 
a  right  to  sue  any  one  who  injures  the  pledge, 
though  preference  is  given  the  pledgee  in  the  matter 
of  suing  because  his  interest  is  generally  greater. 
He  has,  of  course,  the  right  to  recover  the  pledge 
on  payment  of  the  debt  for  which  it  was  given  as 
security,  and  he  cannot  be  deprived  of  this  right  at 
the  time  of  making  the  contract.  To  allow  this 
would  permit  lenders  to  crush  their  customers.  But 
the  pledger's  right  to  redeem  may  be  released  by 
a  subsequent  contract  founded  on  a  new  considera- 
tion. Statutes  in  many  States  allow  a  pawnbroker 
to  sell  the  pledge  and  foreclose  the  pledger's  right 
to  redeem  at  the  expiration  of  a  fixed  time,  gen- 
erally a  year.  As  to  the  liabilities  of  a  pledger,  he 
is,  of  course,  liable  for  the  original  debt,  default  in 
paying  which  may  lead  to  a  sale  of  the  pledge  and 
and  the  application  of  the  proceeds  to  the  debt  so 
far  as  they  will  go.  If  not  sufficient  to  extinguish 
the  debt  he  still'owes  the  balance.  The  pledger  also 
impliedly  warrants  his  title  as  that  of  an  absolute 
owner. 

129.  RIGHTS  AND  LIABILITIES  OF 
PLEDGEE  BEFORE  DEFAULT.— The  pledgee 
gets  no  better  title  than  the  pledgor  had,  except  in 
the  case  of  negotiable  instruments,  and  except 


LOANS   AND    INVESTMENTS        143 

where  the  pledger  has  been  clothed  by  the  owner 
with  the  indicia  of  ownership.  The  best  example 
of  clothing  one  with  the  indicia  of  ownership  occurs 
in  pledges  of  certificates  of  stock.  These  are  not 
regarded  as  negotiable  instruments,  but  the  owner, 
by  endorsing  or  signing  the  power  of  attorney  to 
transfer,  thereby  invests  the  holder  with  the  ap- 
parent ownership,  and  the  latter  may  then  pass  a 
good  title  to  one  who  buys  for  value  without  notice, 
in  good  faith.  There  are  some  limitations  to  this, 
as  where  the  pledgor  is  known  to  be  an  agent  for 
a  trustee  the  pledgee  cannot  take  the  stock  with 
full  protection  unless  he  inquires  into  the  authority 
of  the  representative  to  make  the  pledge.  Where 
the  owner  himself  never  endorsed  the  certificate, 
but  some  one  else  without  authority  did,  that  does 
not  avail  against  the  true  owner  even  in  the  hands 
of  a  pledgee  or  transferee  without  notice  for  value. 
The  owner  of  an  instrument  negotiable  or  non- 
negotiable  cannot  be  precluded  by  a  forgery.  The 
pledgee  having  the  right  of  possession  may  sue  any 
person  who  causes  injury  to  the  pledge,  because  he 
has  generally  a  greater  interest  than  the  owner 
himself  in  keeping  the  pledge  intact. 

130.  RIGHT  TO  THE  USE  AND  PROFITS 
OF  THE  PLEDGE.— The  pledgee  may  use  the 
pledge  so  far  as  is  reasonably  necessary.  Ordin- 
arily this  would  be  little  or  nothing,  but  the  pledgee 
of  a  horse  would  have  to  use  the  pledge  in  order 
to  keep  it  in  condition,  and  in  all  cases  the  pledgee 


144        LOANS   AND    INVESTMENTS 

may  use  the  pledge  as  the  pledger  permits.  The 
pledgee  may  collect  the  profits  or  income  of  the 
pledge,  as  dividends  on  stock  or  interest  on  bonds, 
but  he  must  apply  them  to  the  principal  debt,  and 
if  they  exceed  the  amount  needed,  he  holds  the 
excess  in  trust  for  the  pledger.  The  pledgee  may 
have  pledged  stock  transferred  to  his  name  on  the 
books  of  the  company,  and  this  is  frequently  done, 
and  may  vote  such  stock,  though  in  some  States 
the  pledgee,  upon  the  demand  of  the  pledger,  must 
give  the  latter  a  proxy  to  vote  the  stock.  The 
pledgee  is  liable  for  assessments  on  the  stock  stand- 
ing in  his  name,  though  by  statute  in  some  States 
the  pledger  and  not  the  pledgee  is  liable;  but  the 
pledgee  may  charge  against  his  pledger  the  amount 
so  paid.  The  pledgee  is  entitled  to  be  reimbursed 
for  necessary  expenses  in  keeping  the  pledge.  The 
pledgee  may  assign  his  interest,  and  this  he  does 
by  assigning  both  the  debt  secured  and  the  pledge. 
131.  PLEDGEE'S  RIGHT  TO  HYPOTHE- 
CATE PLEDGED  STOCK.  — Where  a  broker 
purchases  stock  for  a  customer  who  deals  with  him 
on  margin  (creating  the  relation  of  pledger  and 
pledgee),  it  seems  that  the  broker  has  the  right  to 
hypothecate  the  stock,  at  least  to  the  extent  that 
the  broker  has  advanced  his  own  money  in  the  pur- 
chase. He  is  not  bound  to  keep  on  hand  the  identi- 
cal stock  purchased,  but  still  he  must  have  on  hand 
or  under  his  control  at  all  times  ready  for  delivery 
to  his  customer  shares  of  the  same  description, 


LOANS   AND    INVESTMENTS        145 

and  in  amount  sufficient  to  fill  the  customer's  order. 
He  has  no  right  to  pledge  his  customer's  stock 
beyond  this,  and  commits  the  wrong  of  conversion 
if  he  does;  but  if  he  does,  and  there  is  nothing  on 
the  certificate  to  warn  the  broker's  pledgee  that  it 
is  already  pledged,  this  second  pledgee  takes  it 
free  from  any  claims  of  the  customer,  and  need 
not  surrender  it  to  the  owner  (purchaser)  except 
on  payment  of  the  debt  of  the  broker  for  which  it 
was  the  second  time  pledged.  This  is  owing  to  the 
rule  already  discussed  that  one  who  clothes  another 
with  apparent  ownership  cannot  dispute  the  title 
of  a  buyer  or  pledgee  from  such  person  in  good 
faith  for  value  and  without  notice.  The  right  to 
use,  sell,  or  rehypothecate  the  pledge  may  be  given 
by  a  pledge  agreement,  and  is  a  common  clause 
in  collateral  notes. 

132.  REDELIVERY  AND  CONVERSION. 
— The  pledgee  must  redeliver  the  identical  thing 
pledged,  with  the  increase  and  profits,  upon  tender 
of  redemption  by  the  pledger,  except  that  he  need 
not  deliver  the  identical  certificates  of  stock.  If 
the  pledgee  does  not  redeliver  he  is  guilty  of  con- 
version, as  he  is  at  the  time  he  makes  an  unwar- 
ranted use  or  disposal  of  the  pledge.  The  rule  as 
to  measure  of  damage  is  generally  the  value  at  the 
date  of  conversion,  without  reference  to  the  nature 
of  the  pledge.  In  New  York  State  and  in  the 
United  States  courts,  in  the  case  of  conversion  of 
stocks,  it  is  the  highest  value  within  a  reasonable 


146        LOANS   AND    INVESTMENTS 

time  after  the  pledger  becomes  aware  of  the  con- 
version; in  other  States  it  is  the  value  at  date  of 
demand,  or  the  highest  intermediate  value  between 
date  of  conversion  and  the  date  of  trial,  or  the  value 
at  date  of  conversion. 

133.  RIGHTS  OF  PLEDGEE  AFTER  DE- 
FAULT.— The  pledgee  upon  default  in  redemption 
at  the  agreed  time  by  the  pledger,  may  sue  the 
pledger  upon  the  debt  for  which  the  pledge  was 
given  as  security,  and  may  recover  judgment  with- 
out affecting  his  lien  on  the  property  pledged;  the 
property  pledged  may  then  be  applied  on  the 
amount  of  the  debt  as  represented  by  the  judgment. 
After  default  in  redemption  by  the  pledger,  the 
pledgee,  on  notice  to  the  pledgor,  and  demand  of 
performance,  and  on  reasonable  notice  of  the  time 
and  place  of  sale,  may  sell  the  property  pledged  at 
public  sale.  Demand  of  performance  is  waived  by 
positive  refusal  to  perform  after  performance  is 
due,  but  the  pledger's  right  to  notice  of  sale  is  not 
thereby  waived.  This  right  to  sell  applies  to  all 
property  pledged  except  negotiable  instruments; 
these  the  pledgee  must  hold  and  collect  as  they 
become  due  and  apply  the  proceeds  to  the  debt,  in 
the  absence  of  a  special  power  of  sale.  The  reason 
is  that  negotiable  paper  would  never  bring  its  true 
value  on  a  forced  sale.  The  general  power  of  the 
pledgee  to  sell  may  be  modified  or  enlarged  by  the 
pledge  agreement.  Thus  banks  ordinarily  require 
of  their  borrowers  a  note  waiving  notice  of  time 


LOANS   AND    INVESTMENTS        147 

and  place  of  sale,  and  providing  for  private  sale, 
and  many  other  provisions.  A  sale  at  a  recognized 
stock  exchange  has  been  held  to  be  a  sale  at  public 
auction,  but  the  point  has  not  been  clearly  settled. 
The  pledgee,  in  the  absence  of  agreement,  has  no 
right  to  buy  at  the  sale.  If  the  subject  matter  of 
the  pledge  can  be  divided  the  pledgee  may  sell  only 
such  part  as  will  discharge  the  debt;  otherwise  he 
is  liable  for  conversion  of  the  part  not  necessary  to 
be  sold.  The  notice  should  be  served  or  given  to 
the  pledger  in  person,  or  to  an  authorized  agent 
if  the  pledger  have  one. 

134.  TERMINATION     OF     PLEDGE.  —  A 
pledge  is  not  terminated  by  the  death  or  bank- 
ruptcy of  the  pledger,  but  at  the  termination  of 
the  pledge  agreement  the  pledger's  representatives 
may  make  tender  of  the  debt  and  demand  the  prop- 
erty, and  in  default  of  such  tender  the  pledgee  may 
sue  the  pledger's  representatives  or  sell  upon  notice 
to  them.    Payment  terminates  the  pledge  as  does 
redelivery,  tender  or  sale,  and  if  the  pledgee  does 
not  redeliver  on  a  good  and  valid  tender  he  converts 
the  pledge  and  may  be  sued  for  the  value  of  the 
property. 

135.  WAREHOUSEMEN    AND    WARE- 
HOUSE RECEIPTS.— The  law  relating  to  ware- 
housemen and  warehouse  receipts  is  a  branch  of  the 
law  of  bailments.    A  warehouseman  is  one  engaged 
in  the  business  of  storing  goods  for  others  for  com- 
pensation.   He  is  a  bailee  for  hire  and  is  required 


148        LOANS   AND   INVESTMENTS 

by  law  to  use  reasonable  skill  and  diligence,  or 
"ordinary"  care  as  it  is  technically  termed,  in  re- 
spect to  the  property  entrusted  to  him.  Ordinary 
care  is  that  degree  of  care  which  men  of  common 
prudence  would  exercise  under  similar  circum- 
stances with  regard  to  their  own  property.  A  ware- 
houseman is  liable  for  ordinary  negligence,  or  a 
want  of  reasonable  care.  He  is  not  an  insurer 
of  the  goods  and  is  not  responsible  for  their  loss 
where  he  has  exercised  ordinary  care.  A  ware- 
house receipt  is  a  written  acknowledgment  by  a 
warehouseman  that  he  holds  certain  described 
goods  in  store  for  delivery  to  the  person  to  whom 
the  receipt  is  issued  or  to  his  order  where  the 
receipt  is  negotiable.  The  Uniform  Warehouse 
Receipts  Act,  which  is  now  the  law  of  thirty-three 
States,  codifies  and  makes  uniform  the  law  of  ware- 
house receipts. 

136.  COMMON  AND  STATUTORY  LAW. 
— At  common  law,  independent  of  statute,  ware- 
house receipts  were  assignable  by  delivery,  or  by 
endorsement  and  delivery,  and  their  transfer  passed 
to  the  assignee  the  title  of  the  assignor  to  the  prop- 
erty. The  transfer  of  the  warehouse  receipt  had 
the  same  effect  as  delivery  of  the  goods  themselves 
and  vested  in  the  assignee  the  constructive  posses- 
sion, but  he  took  no  better  right  or  title  than  that 
possessed  by  the  assignor.  A  valid  transfer  can  be 
made  by  a  mere  delivery  of  the  receipt  with  intent 
to  pass  title  to  the  goods,  without  endorsement, 


LOANS   AND   INVESTMENTS        149 

and  statutes  authorizing  transfer  of  warehouse  re- 
ceipts by  endorsement  have  been  generally  con- 
strued not  to  invalidate  a  transfer  of  title  by  mere 
delivery.  But  common  law  transfers,  if  they  may 
be  so  called,  did  not  give  to  the  assignee  any  greater 
rights  than  the  assignor  possessed,  and  in  a  large 
number  of  States,  prior  to  the  enactment  of  the 
Warehouse  Receipts  Act,  statutes  were  passed 
declaring  warehouse  receipts  negotiable.  These 
statutes,  however,  have  been  construed  by  the 
courts  as  not  conferring  upon  warehouse  receipts 
the  full  measure  of  negotiability  which  is  possessed 
by  bills  of  exchange  or  promissory  notes.  They 
gave  to  the  holder  to  whom  a  receipt  had  been 
regularly  transferred  by  endorsement,  the  effect  of 
manual  delivery  of  the  goods  represented;  they 
served  to  dispense  with  notice  to  the  warehouse- 
man that  the  receipt  had  been  transferred,  which 
notice  was  generally  otherwise  necessary  to  protect 
the  holder  from  delivery  of  the  goods  to  the  original 
bailor;  and  their  effect  was  to  transfer  the  title  to 
a  bona  fide  purchaser  free  from  any  equities  of 
prior  parties  not  apparent  on  the  face  of  the  in- 
strument. They  did  not,  however,  confer  upon  the 
transferee  title  to  the  goods  as  against  one  who 
had  a  superior  title  to  the  transferor,  nor  confer 
title  where  the  receipt  was  innocently  acquired 
from  a  thief  or  finder,  as  against  the  true  owner. 
The  Uniform  Warehouse  Receipts  Act,  which  codi- 
fies and  makes  uniform  the  common  and  statute 


150        LOANS   AND   INVESTMENTS 

law,  provides  for  two  kinds  of  receipt,  non-negotia- 
ble and  negotiable.  The  non-negotiable  receipt  is 
one  in  which  it  is  stated  that  the  goods  received 
will  be  delivered  to  the  depositor  or  to  any  other 
specified  person.  The  negotiable  receipt  is  one  in 
which  it  is  stated  that  the  goods  will  be  delivered 
to  the  bearer  or  to  the  order  of  any  person  named 
in  such  receipt. 

137.  NON-NEGOTIABLE  WAREHOUSE 
RECEIPTS. — A  non-negotiable  receipt  is  not,  gen- 
erally speaking,  a  document  upon  which  the  banker 
should  advance  value  and  receive  in  pledge.  The 
transferee  acquires  as  against  the  transferor,  the 
title  to  the  goods,  subject  to  the  terms  of  any  agree- 
ment with  the  transferor,  and  he  acquires  the  direct 
obligation  of  the  warehouseman  to  hold  possession 
of  the  goods  for  him  according  to  the  terms  of  the 
receipt.  But  prior  to  such  notification,  the  title  of 
the  transferee  to  the  goods  and  the  right  to  acquire 
the  obligation  of  the  warehouseman  may  be  de- 
feated by  the  levy  of  an  attachment  or  execution 
upon  the  goods  by  a  creditor  of  the  transferee  or 
by  a  notification  to  the  warehouseman  by  the  trans- 
feror or  a  subsequent  purchaser  from  the  transferee 
of  a  subsequent  sale  of  the  goods  by  the  transferor. 
Furthermore,  in  case  the  goods  are  delivered  by  the 
warehouseman  to  the  transferor  prior  to  notifica- 
tion, the  rights  of  the  assignee  or  pledgee  would 
be  endangered,  if  not  defeated,  as  the  warehouse- 
man would  not  be  responsible,  although  the  receipt 


LOANS   AND    INVESTMENTS        151 

was  not  produced  and  surrendered  when  the  de- 
livery was  made.  The  banker,  therefore,  is  not 
particularly  concerned  with  the  non-negotiable 
warehouse  receipt  except  to  let  it  alone  and  to  have 
an  ability  to  know  whether  a  receipt  is  non-nego- 
tiable or  negotiable. 

138.  NEGOTIABLE  WAREHOUSE  RE- 
CEIPTS.— Negotiable  warehouse  receipts  are  very 
extensively  pledged  to  bankers  as  collateral  for 
loans,  but  even  under  the  Uniform  Warehouse 
Receipts  Act  they  do  not  possess  the  full  measure 
of  negotiability  accorded  by  the  law  to  bills  of 
exchange  and  promissory  notes.  They  are  nego- 
tiable by  endorsement  and  delivery,  or  by  delivery 
alone  if  in  form  so  permitting,  in  the  same  way  as 
bills  and  notes,  but  although  the  receipt  is,  in  form, 
capable  of  being  negotiated  by  delivery,  as  by  en- 
dorsement in  blank,  the  bona  fide  transferee  for 
value  from  a  thief  or  finder  takes  no  title  as  against 
the  true  owner.  This  is  one  risk  which  the  banker, 
as  pledgee  for  value,  incurs.  If,  however,  a  person 
entrusted  with  a  negotiable  receipt  by  the  owner 
for  a  special  purpose  abuses  his  trust  and  makes  a 
wrongful  negotiation,  the  bona  fide  transferee  is 
protected  as  against  the  owner.  The  transferee  of 
a  negotiable  receipt  is  also  protected  in  his  right 
to  the  goods  as  against  a  delivery  by  the  warehouse- 
man without  taking  up  the  receipt.  The  Ware- 
house Receipts  Act  requires,  except  in  certain 
special  cases,  such  as  sale  to  satisfy  warehouse- 


152        LOANS   AND    INVESTMENTS 

man's  lien  or  in  case  of  perishable  or  hazardous 
goods,  that  where  a  warehouseman  delivers  goods 
represented  by  a  negotiable  receipt  he  must  take 
up  and  cancel  the  receipt,  or  in  case  of  partial  de- 
livery, make  endorsement  thereon,  and  failure  to 
do  this  makes  him  liable  to  the  holder  for  value  of 
the  outstanding  receipt,  whether  the  same  was  ac- 
quired before  or  after  such  delivery,  and  such  failure 
is  also  made  a  criminal  offense.  This  provision 
applies  only  to  negotiable  receipts  and  without  it 
such  receipts  would  frequently  be  valueless  as  se- 
curity. Goods  represented  by  an  outstanding  ne- 
gotiable receipt  are,  by  the  Warehouse  Receipts 
Act,  exempted  from  attachment  or  garnishment 
by  a  creditor  of  the  depositor  while  in  the  posses- 
sion of  the  warehouseman,  unless  the  receipt  is  first 
surrendered  or  its  negotiation  enjoined.  This  is 
an  important  provision  for  the  protection  of  the 
banker  who  takes  the  receipt  as  security  for  a  loan. 
139.  WAREHOUSEMEN'S  LIABILITY.— 
The  Uniform  Warehouse  Receipts  Act  thus  pro- 
vides the  rule  of  liability  for  contents  of  packages: 
"A  warehouseman  shall  be  liable  to  the  holder  of 
a  receipt  for  damages  caused  by  the  non-existence 
of  the  goods  or  by  the  failure  of  the  goods  to  cor- 
respond with  the  description  thereof  in  the  receipt 
at  the  time  of  its  issue.  If,  however,  the  goods  are 
described  in  a  receipt  merely  by  a  statement  of 
marks  or  labels  upon  them,  or  upon  packages  con- 
taining them,  or  by  a  statement  that  the  goods  are 


LOANS   AND    INVESTMENTS        153 

said  to  be  goods  of  a  certain  kind,  or  that  the  pack- 
ages containing  the  goods  are  said  to  contain  goods 
of  a  certain  kind,  or  by  words  of  like  purport,  such 
statements,  if  true,  shall  not  make  liable  the  ware- 
houseman issuing  the  receipt,  although  the  goods 
are  not  of  the  kind  which  the  marks  or  labels  upon 
them  indicate,  or  of  the  kind  they  were  said  to  be 
by  the  depositor." 

140.  AGENTS  OF  WAREHOUSEMEN.— 
A  further  important  question  is  whether  a  ware- 
houseman, whose  agent  signs  and  issues  a  ware- 
house receipt  for  goods  which  have  not  in  fact  been 
received,  is  responsible  to  a  transferee  of  the  receipt 
for  the  goods  stated  to  have  been  received.  The 
rule  of  the  common  law,  which  has  had  a  more 
extensive  application  to  cases  of  false  bills  of  lading 
issued  by  agents  of  carriers,  was  that  the  principal 
was  not  bound,  as  the  authority  of  the  agent  only 
extended  to  the  issue  of  receipts  where  goods  had 
been  actually  received  and  a  receipt  issued  for  goods 
not  in  fact  received  was  an  act  beyond  the  authority 
of  the  agent  and  not  binding  on  the  principal  even 
in  favor  of  a  bona  fide  holder  of  the  receipt.  A  few 
States,  among  others  New  York  and  Pennsylvania, 
hold  the  principal  liable  for  the  act  of  his  agent  in 
such  cases  upon  the  theory  of  estoppel.  The  Uni- 
form Warehouse  Receipts  Act  in  the  provision  last 
above  quoted  changes  the  common  law  rule.  It 
provides  that  "a  warehouseman  shall  be  liable  to 
the  holder  of  a  receipt  for  damages  caused  by  the 


154        LOANS   AND    INVESTMENTS 

non-existence  of  the  goods  *  *  *"  and  this, 
coupled  with  a  further  provision  of  the  Act  that 
"the  signature  of  the  warehouseman  may  be  made 
by  his  authorized  agent"  makes  him  responsible  to 
a  bona  fide  holder  of  a  warehouse  receipt  which 
•  acknowledges  the  receipt  of  goods  not  in  fact  re- 
ceived. The  banker,  therefore,  who  loans  money 
upon  a  warehouse  receipt  falsely  acknowledging 
the  receipt  of  300  tubs  of  butter,  or  any  other  com- 
modity, can  compel  the  warehouseman  to  make  it 
good. 

141.  WARRANTIES  OF  GENUINENESS.— 
Where  a  receipt  is  negotiated  or  transferred  for 
value,  the  Warehouse  Receipts  Act  provides  a  war- 
ranty by  the  transferor  of  the  receipt  or  of  a  claim 
secured  thereby,  of  the  genuineness  of  the  receipt, 
that  he  has  a  legal  right  to  negotiate  or  transfer  it, 
and  that  he  has  no  knowledge  of  any  fact  which 
would  impair  the  validity  or  worth  of  the  receipt. 
Also  that  he  has  a  right  to  transfer  title  to  the 
goods  and  that  the  goods  are  merchantable  or  fit 
for  a  particular  purpose  whenever  such  warranties 
would  have  been  implied,  if  the  contract  of  the 
parties  had  been  to  transfer  without  a  receipt  the 
goods  represented  thereby.  This  would  enable  a 
banker,  who  took  as  pledge  for  a  loan  a  forged  re- 
ceipt or  a  stolen  receipt  or  a  receipt  for  goods  not 
owned  by  the  person  who  obtained  the  loan,  to  hold 
the  borrower  responsible  upon  his  warranty.  But 
the  law  exempts  a  pledgee  of  the  receipt  who  re- 


LOANS   AND   INVESTMENTS        155 

ceives  payment  of  the  debt  for  which  the  receipt 
is  given  as  security,  either  from  the  drawee  of  a 
draft  therefor  or  from  any  other  person,  from  lia- 
bility as  warrantor  of  the  genuineness  of  the  receipt 
or  of  the  quantity  or  quality  of  the  goods  therein 
described. 

142.  LIABILITY    OF    ENDORSERS.  —  Al- 
though a  person  who  negotiates  and  sells  a  ware- 
house receipt  to  another,  for  value,  warrants  the 
genuineness  of  the  receipt  and  the  other  matters 
above  specified,  he  does  not,  by  endorsing  the  re- 
ceipt, incur  the  ordinary  liabilities  which  attach  to 
the  endorser  of  a  promissory  note  in  case  of  default 
of  the  maker.    The  Warehouse  Receipts  Act  pro- 
vides that  "the  endorsement  of  a  receipt  shall  not 
make  the  endorser  liable  for  any  failure  on  the  part 
of  the  warehouseman  or  previous  endorsers  of  the 
receipt  to  fulfill  their  respective  obligations."    This 
is  the  law  apart  from  the  Warehouse  Receipts  Act 
and  has  been  so  ruled,  even  where  State  statutes 
have  made  warehouse  receipts  negotiable.     The 
liability  is  analogous  to  that  of  an  endorser  "with- 
out recourse"  of  a  promissory  note.    If  the  note  is 
not  paid,  the  endorser  cannot  be  held,  but  if  the 
note  was  a  forgery  or  there  was  any  defect  of  title, 
he  would  be  liable  as  warrantor. 

143.  WAREHOUSEMEN'S     LIENS.  —  The 
warehouseman  has  a  lien  on  the  goods  for  his 
charges,  and  statutes  in  many  States  have  required 
that  his  lien  be  stated  in  the  receipt,  otherwise  he 


156        LOANS   AND   INVESTMENTS 

cannot  enforce  such  lien  against  the  transferee  for 
value  of  the  receipt.  It  is  obvious  that  negotiable 
receipts  should  show  on  their  face  what  charges 
are  claimed  against  the  goods.  The  Uniform 
Warehouse  Receipts  Act  requires  that  every  re- 
ceipt must  embody  "a  statement  of  the  amount  of 
advances  made  and  of  liabilities  incurred  for  which 
the  warehouseman  claims  a  lien.  If  the  precise 
amount  of  such  advances  made  or  of  such  liabilities 
incurred  is,  at  the  time  of  the  issue  of  the  receipt, 
unknown  to  the  warehouseman  or  to  his  agent 
who  issues  it,  a  statement  of  the  fact  that  advances 
have  been  made  or  liabilities  incurred  and  the  pur- 
pose thereof  is  sufficient." 

144.  EXTENSIVE  USE  OF  WAREHOUSE 
RECEIPTS.— A  bona  fide  purchaser  of  a  ware- 
house receipt  is  one  who  has  taken  the  receipt  for 
value  without  notice  of  defect  in  the  title  of  the 
transferor.  A  pledgee  who  takes  a  warehouse  re- 
ceipt as  security  for  a  loan  is  a  purchaser  for  value, 
and  he  acquires  the  pledger's  title  to  the  property, 
so  far  as  necessary  to  effect  the  object  of  the  pledge. 
By  means  of  the  Negotiable  Warehouse  receipt, 
owners  of  millions  of  dollars  of  stored  goods  are 
enabled,  through  pledge  of  the  receipt,  to  obtain 
needed  loans  and  advances  upon  the  security  thereof, 
and  tide  themselves  over  periods  when  the  goods 
are  not  readily  salable.  The  warehouse  receipt  is 
in  many  respects  analogous  to  the  bill  of  lading; 
one  represents  goods  in  store,  the  other  goods  in 


LOANS   AND   INVESTMENTS        157 

transit.  Both  are  now  used  to  an  enormous  extent 
as  instruments  of  credit,  and  loans  and  advances 
which  run  into  the  billions  of  dollars  are  annually 
made  upon  faith  thereof. 

145.  COMMON  CARRIERS.— The  transporta- 
tion of  merchandise  by  water  and  by  land,  f  rom  one 
point  to  another  at  shorter  or  longer  distances,  is 
a  business  of  vast  extent  in  our  modern  commerce. 
The  person  or  corporation  who  conducts  this  busi- 
ness is  termed  a  carrier.  Carriers  are  of  two  classes, 
private  carriers  and  public  or  common  carriers.  A 
private  carrier  is  one  who  undertakes  isolated  cases 
of  transportation  and  whose  usual  vocation  is  dif- 
ferent. He  is  a  bailee  of  the  goods  entrusted  to  him 
and,  like  other  bailees,  is  bound  to  use  ordinary 
care  where  he  carries  for  hire  and  a  less  degree  of 
care  if  the  carriage  is  gratuitous.  A  common  car- 
rier is  one  whose  regular  calling  is  to  transport, 
for  hire,  goods  and  chattels  for  all  who  may  choose 
to  employ  and  remunerate  him.  The  common 
carrier  differs  from  an  ordinary  bailee  in  two  im- 
portant particulars  (1)  he  is  bound,  according  to 
his  facilities,  to  transport  all  goods  which  are 
offered  to  him  when  coupled  with  proper  remunera- 
tion, (2)  his  common  law  liability  is  exceptional. 
He  is  responsible  for  the  goods,  where  lost  or  dam- 
aged, as  an  insurer,  except  where  the  loss  is  caused 
by  act  of  God  or  public  enemy. 

146.    BILLS  OF  LADING.— A  bill  of  lading 
is  a  written  acknowledgment  by  the  carrier  of  the 


158        LOANS   AND   INVESTMENTS 

receipt  of  the  described  goods,  and  an  agreement, 
for  a  consideration,  to  transport  and  deliver  the 
same  at  a  specified  place  to  the  consignee  or  person 
designated  therein.  The  bill  of  lading  must  be 
signed  by  the  carrier,  but  it  has  been  quite  generally 
held,  with  some  few  exceptions,  that  it  need  not 
be  signed  by  the  shipper,  and  that  the  acceptance  of 
the  bill  by  the  shipper  binds  him  to  the  terms  of  the 
contract.  The  Uniform  Bill  of  Lading  Act  provides 
for  the  signature  of  the  shipper,  but  the  shipper  does 
not  always  sign  and  without  his  signature  its  ac- 
ceptance by  him  completes  the  contract  and  binds 
both  parties  to  its  terms.  Bills  of  lading  now  in 
common  use  are  of  two  kinds,  the  Straight  bill  of 
lading  and  the  Order  bill  of  lading.  The  Straight 
bill  of  lading  is  an  acknowledgment  of  the  receipt 
of  goods  and  an  agreement  to  carry  and  deliver  to 
a  named  consignee  at  destination.  When  this 
agreement  is  fulfilled  by  the  carrier  its  contract 
is  performed.  The  Straight  bill  contains  no  con- 
tract of  the  carrier  that  he  will  require  surrender 
of  the  bill  before  delivery  of  the  goods.  The  Order 
bill  of  lading  is  a  like  receipt,  but  the  contract  is  to 
carry  and  deliver  to  the  order  of  a  specified  person, 
generally  the  shipper,  and  it  contains  an  express 
agreement  that  the  surrender  of  the  bill,  properly 
endorsed,  shall  be  required  by  the  carrier  before 
delivery  of  the  property.  In  the  forms  approved 
and  recommended  by  the  Interstate  Commerce 
Commission  and  generally  used  by  carriers,  the 


LOANS   AND    INVESTMENTS         159 

Straight  and  Order  forms  of  bill  are  identical,  in- 
cluding certain  conditions  on  the  back,  except  that 
the  Straight  bill  omits  the  following  matters  con- 
tained in  the  Order  bill:  (1)  the  surrender  clause, 
.(2)  the  inspection  clause,  (3)  the  words  "order  of" 
and  (4)  the  word  "notify,"  indicating  the  person  to 
be  notified  of  the  arrival  of  the  goods. 

147.  NEGOTIATION  OF  ORDER  BILLS.— 
The  Uniform  Bills  of  Lading  Act,  which  has  been 
enacted  in  sixteen  States  and  is  a  companion  act  to 
the  Warehouse  Receipts  Act,  makes  a  distinction 
between  Straight  or  non-negotiable  and  Order  or 
negotiable  bills  of  lading  and  provides  that  "a  nego- 
tiable bill  may  be  negotiated  by  any  person  in 
possession  of  the  same,  however  such  possession 
may  have  been  acquired,  if  by  the  terms  of  the  bill 
the  carrier  undertakes  to  deliver  the  goods  to  the 
order  of  such  person,  or  if  at  the  time  of  negotiation 
the  bill  is  in  such  form  that  it  may  be  negotiated 
by  delivery."  The  Uniform  Bills  of  Lading  Act,  in 
modified  form,  has  also  been  passed  by  Congress 
to  take  effect  January  1,  1917.  It  applies  to  bills  of 
lading  issued  in  interstate  and  foreign  commerce. 
Among  its  provisions  is  the  one  just  quoted  relat- 
ing to  negotiation  of  Order  bills.  This  provision 
gives  a  greater  degree  of  negotiability  than  here- 
tofore to  Order  bills  of  lading,  because  under  it  the 
bona  fide  purchaser  can  acquire  good  title  from  a 
thief  or  finder,  if  endorsed  in  blank  so  as  to  be 
capable  of  negotiation  by  delivery.  Order  bills  of 


160        LOANS   AND   INVESTMENTS 

lading,  however,  are  not  in  all  respects  on  the  same 
footing  as  Straight  bills  of  lading,  for,  as  in  the  case 
of  warehouse  receipts,  there  is  no  liability  of  the 
carrier  as  insurer  of  the  contents  of  packages  where 
he  has  described  such  contents  merely  by  a  state- 
ment of  the  marks  and  labels  upon  them,  and  there 
is  no  liability  of  an  endorser,  as  in  the  case  of  prom- 
issory notes,  for  default  of  the  maker  or  prior  en- 
dorsers. The  banker  who  loans  money  or  makes 
advances  to  one  who  assigns  the  bill  of  lading  as 
security  is  chiefly  concerned  with  the  Order  bill 
of  lading.  The  Straight  bill  of  lading  affords  him 
no  security,  for  there  is  no  obligation  of  the  carrier 
to  hold  possession  of  the  goods  for  the  holder  of 
the  bill,  and  their  delivery  to  the  consignee  before 
notice  of  the  assignment  of  the  bill  of  lading  would 
protect  the  carrier.  The  only  bill  of  lading,  there- 
fore, which  should  be  considered  as  security  by  the 
banker  is  the  Order  bill,  and  even  the  taking  of  this 
bill  as  collateral  is  sometimes  attended  with  certain 
risks. 

148.  FALSE  BILLS.  —  Heretofore  a  serious 
risk  to  the  purchaser  or  pledgee  of  an  Order  bill 
of  lading  has  arisen  from  the  issue  by  the  agent 
of  the  carrier  of  a  bill  of  lading  acknowledg- 
ing the  receipt  of  goods  not  in  fact  received. 
This  might  be  done  (1)  mistakenly,  (2)  fraudu- 
lently, as  by  collusion  where  there  are  no  goods, 
(3)  as  a  matter  of  accommodation  to  the  shipper, 
to  furnish  him  in  advance  with  the  means  of  ob- 


LOANS   AND    INVESTMENTS        161 

taining  credit  and  in  the  expectation  that  the  goods 
for  which  the  bill  has  been  prematurely  issued  will 
be  ultimately  delivered  to  the  carrier  for  transporta- 
tion. By  the  rule  of  the  common  law  which,  before 
the  enactment  by  Congress  of  the  modified  Uniform 
Bills  of  Lading  Act,  entitled  "an  act  relating  to 
bills  of  lading  in  interstate  and  foreign  commerce," 
was  recognized  and  applied  by  the  Federal  courts! 
and  by  many  State  courts,  the  carrier  was  not  liable 
to  a  bona  fide  transferee  or  pledgee  of  the  bill  in 
such  case.  The  authority  of  the  agent  to  sign  and 
issue  bills  of  lading  was  held  to  exist  only  where 
he  had  already  received  the  goods  and  not  to  exist 
in  the  absence  of  such  receipt.  Where  he  signed 
and  issued  a  bill,  therefore,  which  acknowledged 
the  receipt  of  goods  not  in  fact  received,  it  was  his 
own  act  and  not  the  act  of  the  carrier,  and  the  latter 
was  not  bound  to  a  transferee  for  value  of  the  bill. 
In  some  eight  States  the  courts  have  refused  to 
apply  this  rule,  and  have  held  the  carrier  liable  on 
the  ground  that  by  holding  his  agent  out  to  the 
public  as  authorized  to  issue  bills  of  lading  he  has 
clothed  him  with  an  apparent  authority  in  such 
cases  which  the  carrier  is  estopped  to  deny.  In 
some  dozen  or  more  States,  special  statutes  have 
also  been  enacted  making  the  carrier  liable,  and 
such  liability  is  also  provided  by  the  Uniform  Bills 
of  Lading  Act,  wherein  the  issue  or  negotiation 
of  bills  without  goods  is  also  made  a  criminal 
offense.  The  enactment  by  Congress  of  the  Bills  of 


162        LOANS   AND   INVESTMENTS 

Lading  Act  above  referred  to,  provides  such  lia- 
bility in  cases  of  interstate  and  foreign  shipments, 
and  overturns  the  rule  of  non-liability  applied  by 
the  Federal  courts.  The  operation  of  such  rule  is 
now  limited  to  intrastate  shipments  in  a  few  States 
only,  where  the  Uniform  Bills  of  Lading  Act  has 
not  been  passed.  The  establishment  of  a  liability 
of  the  carrier  for  the  truth  of  the  statements  in  the 
bill  of  lading  is  of  vital  importance,  for  otherwise, 
wherever  money  is  loaned  upon  a  bill  of  lading 
acknowledging  the  receipt  of  100  bales  of  cotton, 
or  two  carloads  of  shingles  or  500  sacks  of  potatoes, 
and  no  cotton,  shingles  or  potatoes  are  behind  the 
bill,  the  money  is  lost,  for  in  such  cases  the  shipper 
is  generally  irresponsible.  The  act  of  Congress 
also  makes  it  a  criminal  offense  to  negotiate  or 
transfer  for  value  "a  bill  which  contains  a  false 
statement  as  to  the  receipt  of  the  goods." 

149.  SPENT  BILLS.— Another  but  less  seri- 
ous risk,  owing  to  its  lesser  frequency,  grows  out 
of  the  rule  applied  by  some  State  courts,  though 
not  recognized  in  others,  that  where  the  goods 
represented  by  an  Order  bill  have  been  delivered 
to  a  person  holding  the  bill  and  rightfully  entitled 
thereto,  but  without  requiring  surrender  of  the  bill, 
the  contract  of  the  carrier  has  been  performed,  the 
functions  of  the  bill  have  ceased  and  it  becomes  a 
spent  or  dead  bill.  Where  this  rule  is  applied, 
should  the  holder  of  the  unsurrendered  bill,  after 
receiving  the  goods,  fraudulently  negotiate  the  bill, 


-• 


LOANS   AND   INVESTMENTS        163 

the  holder  would  acquire  no  enforceable  rights,  and 
herein  lies  the  risk.  The  Uniform  Bills  of  Lading 
Act  provides  a  liability  of  the  carrier  to  the  holder 
for  value  to  whom  a  spent  bill  has  been  negotiated, 
and  a  similar  liability  is  provided  by  act  of  Con- 
gress. The  negotiation  of  spent  bills  is  also  made 
criminal  by  the  State  Uniform  Bills  of  Lading  Act. 

150.  ALTERED   BILLS.— At  common  law,  a 
material  alteration  of  a  contract  without  consent 
of  the  person  obligated,  destroyed  it,  and  the  holder 
of  such  altered  contract  had  no  enforceable  rights 
therein.     Both  by  one  of  the  conditions  of  the 
Uniform  Bills  of  Lading  and  by  provision  of  the 
Uniform  Act,  an  altered  contract  is  now  enforceable 
for  its  original  tenor  and  not  destroyed  completely. 
The  act  of  Congress  also  provides  "that  any  alter- 
ation, addition  or  erasure  in  a  bill  after  its  issue 
without  authority  from  the  carrier  issuing  the  same, 
either  in  writing  or  noted  on  the  bill,  shall  be  void, 
whatever  be  the  nature  and  purpose  of  the  change, 
and  the  bill  shall  be  enforceable  according  to  its 
original  tenor."    The  risk  from  acquiring  altered 
bills  has  therefore  been  lessened,  although  there 
is  still  danger  of  loss  in  the  case  of  raised  bills,  as 
where  a  bill  acknowledging  receipt  of  10  boxes  is 
fraudulently  raised  to  100. 

151.  GOODS  NOT  OWNED  BY  SHIPPER. 
— Another,  though  infrequent,  risk  attendant  upon 
the  giving  of  value  upon  the  faith  of  an  Order  bill 
of  lading  arises  in  the  case  where  the  shipper  is 


164        LOANS   AND   INVESTMENTS 

not  owner  of  the  goods  shipped  and  is  wrongfully 
in  possession  of  them.  He  delivers  the  goods  to 
the  carrier  and  receives  an  Order  bill  of  lading 
therefor,  upon  which  he  obtains  an  advance.  The 
holder  of  the  bill  as  security  would,  in  this  case, 
have  no  right  to  the  goods  as  against  the  true 
owner. 

152.  GOODS    LOST    OR    DAMAGED    IN 
TRANSIT.— Where  goods  are  lost  or  damaged 
in  transit  through  a  cause  for  which  the  carrier  is 
exempted  from  responsibility  by  virtue  of  the  con- 
ditions in  the  bill  of  lading,  of  course  there  is  an 
impairment  or  loss  of  the  security,  as  represented 
by  the  bill  of  lading,  unless  there  is  coupled  with 
the  bill  of  lading  an  insurance  contract  against  such 
loss.    But  in  this  particular  case  the  risk  is  not  as 
great  as  might  first  appear,  because  the  shipper  or 
owner  of  the  goods  to  whom  the  advance  has  been 
made  upon  security  of  the  bill  of  lading,  is  generally 
a  responsible  person  who  is  liable  for  and  will  be 
able  to  pay  the  money  loaned,  although  the  security 
for  such  loan  has  been  destroyed.     It  is  only  in 
cases  where  insolvency  or  irresponsibility  of  the 
shipper  or  debtor  is  concurrent  with  loss  of  the 
goods  from  a  cause  for  which  the  carrier  is  not 
responsible  that  the  holder  of  the  security  will 
suffer. 

153.  ATTACHMENT     OF     GOODS     REP- 
RESENTED BY  BILLS  OF  LADING.— Numer- 
ous cases  have  arisen  in  many  of  the  State  courts 


LOANS   AND    INVESTMENTS         165 

where  goods  represented  by  an  Order  bill  of  lading 
outstanding  in  the  hands  of  a  banker  as  pledgee 
for  value  have  been  attached  while  in  the  possession 
of  the  carrier  by  a  creditor  of  the  shipper.  Lower 
courts  in  many  of  these  cases  have  failed  to  recog- 
nize the  rights  of  the  banker  holding  the  bill,  and 
have  sustained  the  attachment;  but  almost  in- 
variably the  higher  courts  of  the  different  States 
have  upheld  his  rights,  as  pledgee  for  value  of  the 
bill,  as  against  the  attaching  creditor.  In  some 
cases  where  the  banker  has  been  proved  to  be  only 
a  collecting  agent  of  the  shipper,  and  not  to  have 
advanced  value  for  or  given  credit  for  the  draft  to 
which  the  bill  of  lading  is  attached,  the  attach- 
ments have  been  held  valid;  but  wherever  the 
banker  has  taken  title  to  the  draft  with  the  bill  of 
lading  as  security  therefor,  whether  the  full  value 
has  been  actually  paid  out  to  the  shipper  or  only 
credited  to  him  in  his  bank  account,  the  superior 
rights  of  the  banker  as  pledgee  of  the  bill  have  been 
upheld.  The  Uniform  Bills  of  Lading  Act  pro- 
vides an  exemption  from  attachment  of  goods  rep- 
resented by  an  outstanding  negotiable  or  Order, 
bill  of  lading  as  follows:  "If  goods  are  delivered 
to  a  carrier  by  the  owner,  or  by  a  person  whose  act 
in  conveying  the  title  to  them  to  a  purchaser  for 
value  in  good  faith  would  bind  the  owner,  and  a  ne- 
gotiable bill  is  issued  for  them,  they  can  not  there- 
after, while  in  the  possession  of  the  carrier,  be 
attached  by  garnishment  or  otherwise,  or  be  levied 


166        LOANS   AND    INVESTMENTS 

upon  under  an  execution,  unless  the  bill  be  first 
surrendered  to  the  carrier  or  its  negotiation  en- 
joined. The  carrier  shall  in  no  such  case  be  com- 
pelled to  deliver  the  actual  possession  of  the  goods 
until  the  bill  is  surrendered  to  him  or  impounded 
by  the  court."  The  same  language  is  contained  in 
the  act  of  Congress  except  that  the  bill  is  termed 
an  "order"  instead  of  a  "negotiable"  bill. 

154.  NON-LIABILITY  OF  PLEDGEE  AS 
WARRANTOR.— In  1898  a  court  in  Texas  held 
that  a  bank  which  had  purchased  a  draft  secured 
by  bill  of  lading  for  wheat  and  collected  the  amount 
of  the  draft  from  the  drawee,  surrendering  to  him 
the  bill  of  lading,  was  liable  to  the  drawee  for  the 
amount  collected  where  it  turned  out  that  the  wheat 
was  musty  and  of  an  inferior  quality  than  that 
contracted  for.  The  theory  of  the  court  was  that 
the  bank  was  not  only  a  purchaser  of  the  draft, 
but  also  a  purchaser  and  seller  of  the  wheat  to 
the  drawee  and  an  implied  warrantor  of  the  se- 
curity. This  doctrine  was  soon  afterwards  fol- 
lowed by  the  Supreme  Courts  of  North  Carolina, 
Alabama  and  Mississippi,  but  was  subsequently 
overturned  in  later  cases  in  three  of  the  four  States 
named,  leaving  the  State  of  Mississippi  as  the  only 
one  whose  courts  still  adhere  to  this  doctrine.  The 
contrary  doctrine,  that  the  bank  purchasing  a  draft 
and  taking  an  assignment  of  the  bill  of  lading  in 
pledge  by  way  of  security  does  not  warrant  the 
genuineness  of  the  bill  or  the  quantity,  quality  or 


LOANS   AND    INVESTMENTS        167 

condition  of  the  goods,  has  been  declared  by  the 
Supreme  Court  of  the  United  States  and  by  a  large 
number  of  State  courts,  and  is  now  expressly  pro- 
vided by  the  Uniform  Bills  of  Lading  Act,  which, 
however,  provides  the  same  warranties  by  seller  to 
purchaser  as  in  case  of  transfer  of  warehouse  re- 
ceipts. Similar  provisions  are  contained  in  the  act 
of  Congress. 

155.  SHIPPER'S  LOAD  AND  COUNT.— 
In  cases  where  the  goods  represented  by  bills  of 
lading  are  loaded  and  counted  by  the  shipper — and 
this  is  frequently  the  case  where  large  factories  are 
located  on  spurs  and  sidings  away  from  the  main 
track  and  away  from  the  railroad  freight  depot — 
the  practice  is  for  the  carrier  to  stamp  on  such 
bills  the  words  "shipper's  load  and  count,"  which 
indicate  that  the  shipper  has  loaded  and  counted 
the  contents  of  a  particular  car  or  shipment,  and 
that  the  carrier  is  not  responsible  for  the  correct- 
ness thereof.  Obviously  such  bills,  although  they 
may  be  Order  bills,  are  not  a  safe  basis  of  collateral, 
for  the  integrity  of  the  bill  as  to  value  of  the  ship- 
ment rests  entirely  on  the  honesty  of  the  shipper, 
and  the  carrier  is  not  responsible.  The  act  of 
Congress  prohibits  the  insertion  of  words  of  this 
character  when  goods  are  loaded  by  the  carrier, 
and  also  in  certain  cases  where  loaded  by  the  ship- 
per; that  is  to  say,  where  the  shipper  of  bulk 
freight  maintains  adequate  facilities  for  weighing 
such  freight,  which  are  available  to  the  carrier,  and 


168        LOANS    AND    INVESTMENTS 

makes  written  request  of,  and  gives  reasonable  op- 
portunity to,  the  carrier  to  ascertain  the  kind  and 
quantity  of  bulk  freight,  the  carrier  must  do  so 
within  reasonable  time,  and  is  prohibited  from  in- 
serting in  the  bill  "shipper's  weight"  or  words  of 
like  purport. 

156.  WORD  "NOTIFY"  ON  ORDER  BILLS. 
— It  is  sometimes  assumed  that  the  word  "notify" 
on  an  Order  bill  of  lading  carries  notice  that  the 
person  to  be  notified  has  some  right  or  equity  in 
the  goods  which  might  be  asserted  as  against  a 
pledgee  for  value,  and  that  it  is  therefore  unsafe  to 
advance  value  upon  such  a  bill.  This  is  an  er- 
roneous assumption.  The  original  form  of  bill  of 
lading  was  the  Straight  bill.  But  as  under  this  bill 
the  carrier  could  deliver  the  goods  to  the  con- 
signee without  taking  up  the  bill,  the  shipper  had 
no  means  of  retaining  the  goods  as  security  until 
he  received  payment  of  the  purchase  price.  The 
practice,  therefore,  became  common  of  issuing  bills 
to  order  of  the  shipper,  under  which  the  carrier  was 
required  to  hold  the  goods  and  make  delivery  only 
to  the  holder  of  and  upon  surrender  of  the  Order 
bill.  The  shipper  would  attach  his  bill  to  a  draft 
and  forward  it  for  collection  and  upon  payment  of 
the  draft  by  the  purchaser  of  the  goods,  the  bill 
would  be  delivered  to  him  and  enable  him  to  obtain 
the  goods  from  the  carrier.  The  word  "notify" 
on  such  bills  simply  indicates  a  request  to  the 
carrier  that  upon  arrival  of  the  goods  he  will  notify 


LOANS   AND   INVESTMENTS        169 

the  person  for  whom  they  are  intended  that  he 
may,  by  paying  the  draft  and  obtaining  possession 
of  and  surrendering  the  bill  of  lading,  receive  de- 
livery of  the  goods.  In  addition  to  sending  the 
draft  and  Order  bill  for  collection,  the  practice  is 
now  common  for  the  shipper  to  obtain  an  advance 
on  the  documents  from  his  local  banker,  who,  as 
owner  of  the  draft  with  the  bill  of  lading  attached 
as  security,  has  the  collection  made  for  his  own 
account.  The  Uniform  Bills  of  Lading  Act  clears 
up  all  doubt  as  to  the  effect  of  the  word  "notify" 
in  an  Order  bill  by  providing  that  "the  insertion  in 
a  negotiable  bill  of  the  name  of  a  person  to  be  noti- 
fied of  the  arrival  of  the  goods  shall  not  limit  the 
negotiability  of  the  bill  or  constitute  notice  to  a 
purchaser  thereof  of  any  rights  or  equities  of  such 
person  in  the  goods."  The  same  provision  is  in  the 
act  of  Congress. 

157.  SURRENDER  OF  BILLS  OF  LADING 
TO  DRAWEES.— Considerable  doubt  has  arisen 
in  the  past  in  the  minds  of  bankers  holding  drafts 
with  bills  of  lading  for  collection,  and  some  litiga- 
tion has  resulted,  concerning  the  duty  of  the  col- 
lecting bank  to  surrender  the  bill  of  lading  to  the 
drawee  upon  acceptance  of  the  draft  or  his  obliga- 
tion to  hold  the  security  until  the  draft  is  actually 
paid.  The  following  provisions  of  the  Uniform 
Bills  of  Lading  Act  thus  regulate  the  subject  in 
accordance  with  the  weight  of  authority:  Where 
the  seller  of  goods  draws  on  the  buyer  for  the  price 


170        LOANS   AND   INVESTMENTS 

of  the  goods  and  transmits  the  draft  and  a  bill  of 
lading  for  the  goods  either  directly  to  the  buyer  or 
through  a  bank  or  other  agency,  unless  a  different 
intention  on  the  part  of  the  seller  appears,  the 
buyer  and  all  other  parties  interested  shall  be  justi- 
fied in  assuming:  (a)  If  the  draft  is  by  its  terms 
or  legal  effect  payable  on  demand  or  presentation 
or  at  sight,  or  not  more  than  three  days  thereafter 
(whether  such  three  days  be  termed  days  of  grace 
or  not),  that  the  seller  intended  to  require  pay- 
ment of  the  draft  before  the  buyer  should  be  en- 
titled to  receive  or  retain  the  bill,  (b)  If  the  draft 
is  by  its  terms  payable  on  time,  extending  beyond 
three  days  after  demand,  presentation  or  sight 
(whether  such  three  days  be  termed  days  of  grace 
or  not),  that  the  seller  intended  to  require  accept- 
ance, but  not  payment  of  the  draft  before  the  buyer 
should  be  entitled  to  receive  or  retain  the  bill.  The 
provisions  of  this  section  are  applicable  whether 
by  the  terms  of  the  bill  the  goods  are  consigned  to 
the  seller,  or  to  his  order,  or  to  the  buyer,  or  to  his 
order,  or  to  a  third  person,  or  to  his  order.  These 
provisions,  however,  are  not  contained  in  the  Act 
of  Congress. 

158.  COLLATERAL  NOTES.— Banks  doing 
an  extensive  collateral  loan  business  usually  have 
a  special  form  of  collateral  note.  Such  forms  vary 
in  some  particulars  but  the  following  is  a  typical 
specimen: 


LOANS   AND   INVESTMENTS        171 

New  York ,191 

$ 

after  date,  FOR  VALUE  RECEIVED,  the 

undersigned  jointly  and  severally  promise  to  pay  to  the 
order  of  THE  INSTITUTE  BANK  OF  NEW  YORK 
(hereinafter  called  the  Bank),  at  its  Banking  Office  in  New 

York  City, DOLLARS,  in  United 

States  gold  coin  or  its  equivalent,  having  deposited  with  the 
Bank,  as  collateral  security  for  the  payment  of  this  note,  or 
any  note  given  in  extension  or  renewal  thereof,  as  well  as 
for  the  payment  of  any  other  obligation  or  liability,  direct 
or  contingent,  of  the  undersigned,  or  any  of  them,  to  the 
Bank,  due  or  to  become  due,  whether  now  existing  or  here- 
after arising,  the  following  property,  viz. : 

[Space  for  enumeration  of  collateral] 

of  a  market  value  estimated  by  the  undersigned  at  $ '; 

and  the  undersigned  agree  to  deliver  to  the  Bank  additional 
securities,  or  to  make  payments  on  account  to  its  satisfac- 
tion, should  the  market  value  of  the  said  securities,  as  a 
whole,  suffer  any  decline.  The  undersigned  hereby  give  to  the 
Bank  a  lien  for  the  amount  of  all  such  obligations  and  liabili- 
ties upon  all  the  property  or  securities  now  or  at  any  time 
hereafter  given  unto  or  left  in  the  possession  of  the  Bank  by 
the  undersigned,  whether  for  the  express  purpose  of  being 
used  by  the  Bank  as  collateral  security,  or  for  any  other  or 
different  purpose,  and  also  upon  any  balance  of  the  deposit 
account  of  the  undersigned,  or  any  of  them,  with  the  Bank. 
On  the  non-performance  of  this  promise,  or  upon  the  non- 
payment of  any  of  the  obligations  or  liabilities  above  men- 
tioned, or  upon  the  failure  of  the  undersigned,  forthwith, 
with  or  without  notice,  to  furnish  satisfactory  additional 
securities,  or  to  make  payments  on  account,  in  case  of  de- 
cline, as  aforesaid,  or  in  case  of  insolvency,  bankruptcy,  or 
failure  in  business  of  the  undersigned,  or  any  of  them,  then 
and  in  any  such  case,  this  note  and  all  other  obligations  and 


172        LOANS   AND   INVESTMENTS 

liabilities,  direct  or  contingent,  of  the  undersigned  and  each 
of  them,  shall  forthwith  become  due  and  payable,  without 
demand  or  notice;  and  full  power  and  authority  are  hereby 
given  to  the  Bank  to  sell,  assign,  and  deliver  the  whole  of 
the  said  securities,  or  any  part  thereof,  or  any  substitutes 
therefor,  or  any  additions  thereto,  or  any  other  securities 
or  property  given  unto  or  left  in  the  possession  of  the  Bank 
by  the  undersigned,  whether  for  the  express  purpose  of  be- 
ing used  by  the  Bank  as  collateral  security,  or  for  any  other 
or  different  purpose,  or  in  transit  to  or  from  the  Bank,  by 
mail  or  carrier,  for  any  of  the  said  purposes,  at  any  broker's 
board,  or  at  public  or  private  sale,  at  the  option  of  the  Bank, 
without  either  demand,  advertisement  or  notice  of  any  kind, 
all  of  which  are  hereby  expressly  waived.  At  any  such  sale, 
the  Bank  may  itself  purchase  the  whole  or  any  part  of  the 
property  sold,  free  from  any  right  of  redemption  on  the  part 
of  the  undersigned,  which  is  hereby  waived  and  released. 
In  case  of  any  sale  or  other  disposition  of  any  of  the  prop- 
erty aforesaid,  after  deducting  all  costs,  or  expenses  of  every 
kind  for  collection,  sale  or  delivery,  the  Bank  may  apply  the 
residue  of  the  proceeds  of  the  sale  or  sales  so  made,  to  pay 
one  or  more  or  all  of  the  said  obligations  or  liabilities  to  it, 
whether  then  due  or  not  due,  making  proper  rebate  for  inter- 
est on  obligations  or  liabilities  not  then  due,  and  returning 
the  overplus,  if  any,  to  the  undersigned,  who  agree  to  be 
and  remain  liable,  jointly  and  severally,  to  the  Bank  for  any 
deficiency  arising  upon  such  sale  or  sales.  The  undersigned 
do  hereby  authorize  and  empower  the  Bank,  at  its  option, 
at  any  time,  to  appropriate  and  apply  to  the  payment  and 
extinguishment  of  any  of  the  obligations  or  liabilities,  here- 
inbefore referred  to,  whether  now  existing  or  hereafter  con- 
tracted and  whether  then  due  or  not  due,  any  and  all  moneys 
now  or  hereafter  in  the  hands  of  the  Bank,  on  deposit  or 
otherwise,  to  the  credit  of  or  belonging  to  the  undersigned, 
or  any  of  them. 


LOANS   AND   INVESTMENTS        173 

The  Bank  may  transfer  this  note  and  may  deliver  the  said 
collateral  security  or  any  part  thereof  to  the  transferee  or 
transferees,  who  shall  thereupon  become  vested  with  all  the 
powers  and  rights  above  given  to  the  Bank  in  respect  there- 
to; and  the  Bank  shall  thereafter  be  forever  relieved  and 
fully  discharged  from  any  liability  or  responsibility  in  the 
matter.  No  delay  on  the  part  of  the  holder  hereof,  in  exer- 
cising any  rights  hereunder,  shall  operate  as  a  waiver  of 
such  rights. 

1 59.  COLLATERAL  LOAN  AGREEMENTS. 
— Sometimes  a  special  form  of  contract  similar  to 
the  following  is  made  between  banks  and  regular 
loan  customers : 

WHEREAS,  the  undersigned  expect,  from  time  to  time,  to 
borrow  money  from  THE  INSTITUTE  BANK  OF  NEW 
YORK  (hereinafter  called  the  Bank)  and  to  pledge  with  the 
Bank  property  of  various  kinds  as  collateral  security  for  the 
payment  of  such  loan  or  loans  to  be  hereafter  made  by  the 
Bank;  Now,  therefore, 

IT  IS  AGREED  by  the  undersigned  with  the  Bank,  that  all 
property  thus  pledged  with  it  may  be  held  by  it  as  collateral 
security  for  the  payment  of  such  loan  or  loans  as  well  as  for 
the  payment  of  any  other  obligation  or  liability,  direct  or 
contingent,  of  the  undersigned,  or  any  of  them,  to  the  Bank, 
due  or  to  become  due,  whether  now  existing  or  hereafter 
arising;  and  the  undersigned  agree  to  deliver  to  the  Bank 
additional  securities,  or  to  make  payments  on  account  to  its 
satisfaction,  should  the  market  value  of  the  said  securities, 
as  a  whole,  suffer  any  decline.  The  undersigned  hereby 
give  to  the  Bank  a  lien  for  the  amount  of  all  such  obligations 
and  liabilities  upon  all  the  property  or  securities  now  or  at 
any  time  hereafter  given  unto  or  left  in  the  possession  of  the 
Bank  by  the  undersigned,  whether  for  the  express  purpose 
of  being  used  by  the  Bank  as  collateral  security,  or  for  any 


174        LOANS   AND    INVESTMENTS 

other  or  different  purpose,  and  also  upon  any  balance  of 
the  deposit  account  of  the  undersigned,  or  any  of  them, 
with  the  Bank. 

On  the  non-performance  of  this  promise,  or  upon  the  non- 
payment of  any  of  the  obligations  or  liabilities  above  men- 
tioned, or  upon  the  failure  of  the  undersigned,  forthwith, 
with  or  without  notice,  to  furnish  satisfactory  additional 
securities,  or  to  make  payments  on  account,  in  case  of  de- 
cline, as  aforesaid,  or  in  case  of  insolvency,  bankruptcy,  or 
failure  in  business  of  the  undersigned,  or  any  of  them,  then 
and  in  any  such  case,  all  obligations  and  liabilities,  direct 
or  contingent,  of  the  undersigned  and  each  of  them,  shall 
forthwith  become  due  and  payable  without  demand  or 
notice ;  and  full  power  and  authority  are  hereby  given  to  the 
Bank  to  sell,  assign,  and  deliver  the  whole  of  the  said  se- 
curities, or  any  part  thereof,  or  any  substitutes  therefor,  or 
any  additions  thereto,  or  any  other  securities  or  property 
given  unto  or  left  in  the  possession  of  the  Bank  by  the 
undersigned,  whether  for  the  express  purpose  of  being  used 
by  the  Bank  as  collateral  security,  or  for  any  other  or  differ- 
ent purpose,  or  in  transit  to  or  from  the  Bank,  by  mail  or 
carrier,  for  any  of  the  said  purposes,  at  any  broker's  board, 
or  at  public  or  private  sale,  at  the  option  of  the  Bank,  with- 
out either  demand,  advertisement  or  notice  of  any  kind,  all 
of  which  are  hereby  expressly  waived.  At  any  such  sale, 
the  Bank  may  itself  purchase  the  whole  or  any  part  of  the 
property  sold,  free  from  any  right  of  redemption  on  the  part 
of  the  undersigned,  which  is  hereby  waived  and  released. 
In  case  of  any  sale  or  other  disposition  of  any  of  the  prop- 
erty aforesaid,  after  deducting  all  costs,  or  expenses  of  every 
kind  for  collection,  sale  or  delivery,  the  Bank  may  apply  the 
residue  of  the  proceeds  of  the  sale  or  sales  so  made,  to  pay 
one  or  more  or  all  of  the  said  Obligations  or  liabilities  to  it, 
whether  then  due  or  not  due,  making  proper  rebate  for  inter- 
est on  obligations  or  liabilities  not  then  due,  and  returning 


LOANS   AND   INVESTMENTS        175 

the  overplus,  if  any,  to  the  undersigned,  who  agree  to  be 
and  remain  liable,  jointly  and  severally,  to  the  Bank  for  any 
deficiency  arising  upon  such  sale  or  sales.  The  undersigned 
do  hereby  authorize  and  empower  the  Bank,  at  its  option,  at 
any  time,  to  appropriate  and  apply  to  the  payment  and 
extinguishment  of  any  of  the  obligations  or  liabilities,  here- 
inbefore referred  to,  whether  now  existing  or  hereafter  con- 
tracted and  whether  then  due  or  not  due,  any  and  all  moneys 
now  or  hereafter  in  the  hands  of  the  Bank,  on  deposit  or 
otherwise,  to  the  credit  of  or  belonging  to  the  undersigned, 
or  any  of  them. 

The  Bank  may  assign  or  transfer  this  instrument  and  may 
deliver  the  said  collateral  security  or  any  part  thereof  to 
the  transferee  or  transferees,  who  shall  thereupon  become 
vested  with  all  the  powers  and  rights  above  given  to  the 
Bank  in  respect  thereto;  and  the  Bank  shall  thereafter  be 
forever  relieved  and  fully  discharged  from  any  liability  or 
responsibility  in  the  matter.  No  delay  on  the  part  of  the 
holder  hereof,  in  exercising  any  rights  hereunder,  shall 
operate  as  a  waiver  of  such  rights. 

On  the  back  of  collateral  notes  and  collateral  loan 
agreements  some  such  provision  as  the  following 
may  be  printed:  "In  consideration  of  one  dollar 
paid  to  the  undersigned,  and  of  the  making,  at  the 
request  of  the  undersigned,  of  the  loan  evidenced 
by  the  within  note,  the  undersigned  hereby  jointly 
and  severally  guarantee  to  The  Institute  Bank  of 
New  York,  its  successors,  indorsees  or  assigns,  the 
punctual  payment,  at  maturity,  of  the  said  loan, 
and  hereby  assent  to  all  the  terms  and  conditions 
of  the  said  note,  and  consent  that  the  securities  for 
the  said  loan  may  be  exchanged  or  surrendered 
from  time  to  time,  or  the  time  of  payment  of  the 


176        LOANS    AND    INVESTMENTS 

said  loan  extended,  without  notice  to  or  further 
assent  from  the  undersigned,  who  will  remain  bound 
upon  this  guaranty,  notwithstanding  such  changes, 
surrender  or  extension." 


CHAPTER  V 

Seasonal  Demands  for  Money 

160.  SEASONAL  MOVEMENTS  IN  MONEY 
MARKETS.— The  demand  for  money  in  the  United 
States  is  seasonal  in  character.  This  fact  is  largely 
due  to  conditions  pertaining  to  the  marketing  of 
agricultural  crops.  Seasonal  demands  for  money 
vary  to  some  extent  in  different  sections  of  the 
country  in  accordance  with  local  conditions,  but 
the  seasonal  swings  manifested  in  New  England, 
the  Middle  States,  and  the  district  tributary  to 
Chicago,  are  essentially  the  same.  Since  this  terri- 
tory includes  New  York  City,  the  country's  domi- 
nant money  market,  it  may  be  taken  as  typical. 
This  territory  shows  five  important  seasonal  periods 
which  may  be  briefly  described  as  follows: 

(1)  Throughout  January  and  during  the  early 
part  of  February  there  is  normally  a  pronounced 
"easing  up"  of  the  money  market.  By  the  fore 
part  of  January  the  crop-moving  demand  for  money 
in  the  West  and  South  is  over  and  the  return  flow 
of  cash  is  at  its  height.  There  is  a  natural  reaction 
—in  part  psychological — which  results  from  the 
relaxing  of  the  heavy  strain  on  the  money  market 
incident  to  January  1  settlements  and  to  the  pass- 
ing of  the  holiday  season.  At  this  time  freight 
traffic,  both  on  the  railroads  and  the  inland  water- 
ways, is  relatively  small. 

177 


178        LOANS   AND    INVESTMENTS 

(2)  The  next  seasonal  movement  is  the  "spring 
trade  revival/'  beginning  about  the  middle  of  Feb- 
ruary and  extending  until  the  latter  part  of  March 
or  the  fore  part  of  April  (in  some  years  a  week  or 
so  later).    This  recovery  is  stimulated  by  the  cheap 
money  prevailing  during  the  preceding  period,  rail- 
road traffic  is  released  from  the  incubus  of  cold 
weather  and  snow,  and  the  inland  waterways  are 
opened  up;  on  April  1  comes  the  demand  for  large 
interest  and  dividend  settlements,  and  in  this  period 
comes  the  spring  demand  of  agriculturists  for  the 
planting  of  the  crops. 

(3)  The  third  important  seasonal  movement  is 
the  weakening  money  market  of  the  late  spring, 
followed  by  the  summer  depression.    This  period 
extends  from  the  fore  part  or  middle  of  April  to 
the  fore  part  of  August.     It  is  interrupted  by  a 
temporary  reaction  about  July  1,  the  time  of  semi- 
annual settlements.    This  period  shows  the  natural 
reaction  from  the  high  rates  of  the   preceding 
period,  the  anticipation  and  later  the  realization 
of  the  hot  months  of  summer  comprising  the  vaca- 
tion period,  the  lessened  demand  for  funds  in  the 
middle  West  after  the  planting  of  the  crops,  and 
the  resulting  return  of  cash  to  New  York.    The 
declining  and  cheap  money  market  at  this  time, 
which  finds  expression  in  such  phenomena  as  large 
bank  reserves,  low  percentage  of  loans  to  deposits, 
low  interest  rates,  gold  exportations,  and  high 
security  prices,  is  to  some  extent  self -corrective. 


LOANS   AND    INVESTMENTS        179 

(4)  The    crop-moving    period    is    the    fourth 
period.    This  period,  the  discounted  beginning  of 
which  is  evidenced  by  the  upward  turn  of  inter- 
est rates  on  sixty  to  ninety  day  commercial  paper 
and  four  months'  time  paper  as  early  as  the  first 
week  in  July,  may  perhaps  best  be  dated  from  the 
first  week  in  August,  when  call  rates  begin  their 
upward  movement  and  when  bank  reserves  begin 
their  decline.     Under  the  pressure  of  the  crop- 
moving  demand  for  cash  in  the  West  and  South, 
bank  reserves  are  depleted  and  the  money  market 
tightens  rapidly  until  about  October  1. 

(5)  The  fifth  and  last  seasonal  period  in  the 
New  York  money  market  extends  from  about  the 
first  week  in  October  to  the  opening  of  the  new 
year.     It  is  a  period  of  considerable  uncertainty 
and  of  many  minor  fluctuations,  but  the  demand 
for  moneyed  capital  continues  large  until  after  the 
holiday   season    and   January    settlements.      The 
westward  movement  of  cash  falls  off  rapidly  in 
November  and  December,  and  by  the  latter  month 
the  return  flow  has  set  in.    The  southward  move- 
ment declines  in  November,  but  shows  some  signs 
of  increasing  temporarily  in  December.    Gold  im- 
ports reach  a  low  point  in  December. 

Doubtless  the  Federal  Reserve  System  will  exer- 
cise a  large  influence  in  the  direction  of  lessening 
the  extent  of  these  seasonal  fluctuations,  and  pos- 
sibly also  some  influence  upon  the  delimitations  of 
the  periods  themselves.  Seasonal  demands  for 


180        LOANS   AND    INVESTMENTS 

money,  however,  are  organic,  and  while  new  bank- 
ing conditions  may  diminish  their  acuteness,  the 
problem  of  periodical  variations  promises  to  con- 
tinue to  complicate  the  banking  business. 

161.  SEASONAL  VARIATIONS  IN  NEW 
ENGLAND. — A  comprehensive  study  of  the  causes 
and  effects  of  seasonal  demands  for  money  was 
made  a  few  years  ago  by  Professor  E.  W.  Kem- 
merer  of  Princeton  University,  and  published  by 
the  Monetary  Commission.  According  to  Professor 
Kemmerer,  currency  movements  to  and  from  New 
England  are  principally  to  and  from  the  Eastern 
States  (almost  entirely  New  York  City).  In  Janu- 
ary there  is  a  strong  movement  of  cash  from  New 
England  to  New  York  City,  in  part  the  result  of 
large  purchases  of  cotton  by  manufacturers  in 
Massachusetts  and  vicinity,  and  in  part  probably 
the  result  of  the  return  flow  of  cash  to  the  banks 
after  the  holiday  demand  and  of  the  call  for  New 
York  remittances  in  settlement  of  holiday  pur- 
chases. February  shows  a  comparatively  small 
movement  of  cash  in  both  directions.  March  and 
April  are  characterized  by  heavy  shipments  of  cash 
from  New  York  City  to  New  England,  caused  in 
part  by  the  heavy  demand  for  remittances  to  Massa- 
chusetts manufacturers  by  western  and  southern 
jobbers  and  in  part  probably  by  the  spring  needs 
of  New  England  farmers.  May,  June  and  July 
appear  to  be  moderately  inactive  months,  so  far 
as  currency  movements  between  New  England  and 


LOANS   AND   INVESTMENTS        181 

the  Eastern  States  are  concerned,  with  some  flow 
of  cash  in  both  directions,  but  no  great  preponder- 
ance in  one  direction  over  the  other.  For  August, 
September  and  October  the  movement  is  toward 
New  England.  The  August  movement  is  at  least 
in  part  due  to  the  preparation  on  the  part  of  New 
England  bankers  for  an  anticipated  difficulty  in 
getting  funds  from  New  York  in  the  autumn,  when 
New  York  banks  are  subject  to  such  large  calls 
from  the  West  and  South.  The  September  and 
October  movement  is  largely  due  to  remittances 
made  at  that  time  by  jobbers  in  the  West  and  South 
in  settlement  of  accounts  for  the  purchase  of  shoes, 
dry  goods,  and  other  articles  of  New  England 
manufacture.  For  November  and  December  cash 
tends  to  flow  from  New  England  to  New  York  City, 
in  response  to  the  large  purchases  of  cotton  by  New 
England  manufacturers  during  these  months,  the 
drafts  upon  the  mills  for  cotton  coming  mainly 
through  New  York. 

162.— SEASONAL  VARIATIONS  IN  THE 
MIDDLE  WEST.— New  York  exchange  in  Chi- 
cago is  normally  high  throughout  January,  and 
there  is  a  strong  movement  of  cash  from  Chicago 
to  New  York  at  that  time.  The  crop  moving  and 
holiday  demand  being  over,  money  tends  to  be  rela- 
tively cheap  in  Chicago,  and  flows  to  New  York 
City,  where  it  is  absorbed  somewhat  in  speculative 
activity  and  in  the  higher  security  prices  which 
normally  rule  the  latter  part  of  January  and  the 


182        LOANS   AND   INVESTMENTS 

fore  part  of  February.  From  the  last  of  January 
to  the  fore  part  of  March,  New  York  exchange 
tends  to  fall,  and  shipments  of  cash  from  Chicago 
to  the  Eastern  States  are  very  small.  During  this 
period  the  demand  for  money  in  Chicago  is  in- 
creased by  the  anticipated  opening  of  navigation 
on  the  Great  Lakes,  the  demand  on  the  part  of 
western  bankers  for  currency  to  meet  the  spring 
needs  of  farmers,  and  by  the  fact  that  the  first  of 
March  in  many  sections  of  the  Middle  West  is 
the  commonest  time  for  making  settlements  of 
interest  and  principal  on  farm  mortgages.  New 
York  exchange  reaches  its  minimum  (for  this  part 
of  the  year)  early  in  March,  and  then  advances 
rapidly  until  it  reaches  its  maximum  for  the  year 
the  latter  part  of  May.  It  then  continues  at  a 
high  level  until  early  in  July,  when  the  crop  mov- 
ing demands  begin  to  make  themselves  felt.  About 
the  first  of  July  New  York  exchange  begins  to  fall 
in  response  to  the  crop  moving  demand,  declining 
rapidly,  with  minor  interruptions,  until  early  in 
September,  and  then  maintaining  a  low  level  until 
the  fore  part  of  November.  There  is  a  strong 
movement  of  currency  from  the  Eastern  States  to 
Chicago  in  August,  September  and  October,  reach- 
ing its  maximum  for  the  year  in  October.  During 
the  last  seven  or  eight  weeks  of  the  year,  the  crop 
moving  demand  having  subsided,  New  York  ex- 
change tends  to  rise,  and  the  return  movement  of 
cash  to  the  East  begins.  The  seasonal  movements 


a  LOANS   AND    INVESTMENTS        183 

in  New  York  exchange  in  St.  Louis  are  similar  to 
those  in  Chicago.  The  seasonal  currency  move- 
ments between  Chicago  and  the  Eastern  States  are 
fairly  representative  of  those  between  the  Middle 
Western  States  as  a  whole  and  the  Eastern  States. 
163.  MIDDLE  WEST  AND  SOUTHERN 
STATES. — Currency  movements  between  the  Mid- 
dle Western  States  and  the  Southern  States  are 
large,  and  afford  valuable  evidence  as  to  the  sea- 
sonal variations  in  the  demand  for  money  in  the 
two  sections  compared  with  each  other.  January 
is  clearly  the  month  of  largest  receipts  by  the 
Middle  Western  States  from  the  Southern  States. 
This  January  movement  is  apparently  the  return 
movement  of  cash  after  the  crop  moving  demand 
in  the  South  has  subsided,  and  it  is  largely  to  St. 
Louis  and  Chicago — principally  the  former.  While 
there  is  a  pronounced  falling  off  in  February  in 
this  flow  of  cash  to  the  Middle  Western  States, 
it  continues,  nevertheless,  in  substantial  amounts 
for  several  months,  with  May  as  the  second  highest 
month  of  the  year.  Beginning  about  the  first  of 
May,  the  banks  in  the  winter  wheat  section  are 
called  upon  to  finance  the  winter  wheat  crop,  and 
this  fact  may  explain  in  part  the  strong  movement 
of  cash  from  the  South  in  May.  Receipts  of  the 
Middle  Western  States  from  the  Southern  States 
decline  rapidly  from  June  to  November,  and,  con- 
temporaneously, there  is  an  increasing  movement 
of  cash  in  the  opposite  direction,  culminating  in 


184        LOANS   AND    INVESTMENTS 

October,  and  apparently  showing  that,  despite  the 
great  needs  of  the  Middle  West  for  cash  in  the 
crop  moving  season,  the  needs  of  the  South  are 
sufficiently  greater  to  make  the  flow  of  cash 
strongly  southward  from  the  Middle  West.  Sep- 
tember and  October  have  been  found  to  be  clearly 
the  months  of  largest  movements  of  cash  from  the 
Middle  Western  States  to  the  Southern  States, 
while  January  has  been  found  to  be  the  month  of 
largest  movement  of  cash  in  the  opposite  direction. 
November  and  December  show  considerable  move- 
ments of  cash  in  both  directions,  and  may  perhaps 
best  be  classed  as  transitional  months. 

164.  SEASONAL  VARIATIONS  IN  THE 
SOUTH.  —  New  York  exchange  in  New  Orleans 
shows  the  usual  advance  during  the  fore  part  of 
January,  in  response  to  the  demands  for  New  York 
funds  for  investment  during  the  slack  season  in 
the  South.  As  the  funds  are  transferred,  there  is 
naturally  a  decline  (extending  from  about  the  third 
to  the  eighth  week),  after  which  exchange  exhibits 
no  important  seasonal  movements  until  about  the 
middle  of  May.  From  then  until  about  the  middle 
of  June  exchange  tends  to  advance.  During  the 
next  three  weeks  there  is  a  reaction,  followed  by 
a  temporary  advance,  extending  from  about  the 
middle  of  July  to  the  middle  of  August.  The 
southern  crop  moving  demand  begins  in  earnest 
about  the  middle  of  August,  when  bills  against 
crop  shipments  are  offered  in  large  quantities,  and 


LOANS   AND   INVESTMENTS        185 

exchange  is  forced  down  rapidly  and  almost  con- 
tinuously until  the  minimum  rates  of  the  year  are 
reached  in  the  fore  part  of  November.  The  crop 
moving  demand  having  reached  its  high  point  about 
the  forty-fifth  week,  the  return  flow  of  cash  from 
nearby  agricultural  communities  to  New  Orleans 
sets  in,  money  becomes  more  plentiful,  and  ex- 
change rates  advance,  the  upward  movement  being 
expedited  by  the  holiday  demand  for  New  York 
exchange  and  by  the  demand  incident  to  January 
settlements.  January  is  the  month  of  strongest 
movements  of  cash  from  the  South  toward  the 
Eastern  States.  The  five  months,  February  to 
June,  inclusive,  are  months  of  moderate  move- 
ments of  cash  toward  the  Eastern  States.  Begin- 
ning with  July,  there  is  an  increasing  movement 
in  the  opposite  direction,  culminating  in  September 
and  October,  when  the  crop  moving  demand  is  at 
its  height.  In  November  and  December  there  is 
considerable  movement  in  both  directions,  and 
those  months  may  best  be  classed  as  transitional 
months  between  the  southward  crop  moving  flow 
of  September  and  October  and  the  northward 
return  flow  of  January. 

165.  SEASONAL  VARIATIONS  ON  THE 
PACIFIC  COAST.— From  the  beginning  of  Janu- 
ary until  about  the  first  of  March,  New  York 
exchange  in  San  Francisco  rises  rapidly.  January 
and  February  are  months  of  relatively  large  ship- 
ments of  cash  from  San  Francisco  to  the  Eastern 


186        LOANS   AND   INVESTMENTS 

Vt.- 

States.  Among  the  principal  causes  may  be  men- 
tioned the  fact  that  advances  which  have  been  made 
for  the  movement  of  general  crops  are  being  repaid 
rapidly,  the  demand  for  eastern  remittances  to  pay 
bills  incurred  for  holiday  purchases,  and  the  desire 
of  local  taxpayers  to  get  movable  funds  out  of  the 
State  the  latter  part  of  February  before  the  tax 
returns  of  the  first  Monday  in  March  are  made  to 
the  assessors.  From  the  fore  part  of  March  to  the 
fore  part  of  June,  the  general  tendency  of  New 
York  exchange  is  upward,  although  there  are  minor 
interruptions.  March,  April  and  May  are  months 
of  comparatively  small  shipments  of  cash  by  San 
Francisco  to  the  Eastern  States,  and  the  shipments 
in  the  opposite  direction  are  of  little  importance. 
During  the  latter  part  of  June,  New  York  exchange 
temporarily  advances,  probably  in  response  to 
demands  for  remittances  east  to  meet  July  settle- 
ments. Exchange  rates  decline  from  about  the 
first  week  in  July  to  the  fore  part  of  September. 
This  decline  is  not  sufficient  to  bring  about  the 
shipment  of  cash  to  San  Francisco  from  the  Eastern 
States.  It  is,  however,  sufficient  to  reduce  the  east- 
ward flow  of  cash.  The  decline  is  probably  due  to 
the  large  amount  of  eastern  credits  available  locally 
at  this  time  from  the  shipments  of  California 
products,  especially  green  fruits,  to  eastern  points. 
From  about  the  middle  of  September  to  the  latter 
part  of  October,  New  York  exchange  tends  to  rule 
at  near  par.  During  this  period  the  outward  move- 


LOANS   AND    INVESTMENTS        187 

ments  of  grain,  green  fruit,  and  fish,  tend  to  force 
exchange  down,  while  the  facts  that  this  is  the 
quarter  of  large  receipts  of  gold  from  Alaska,  mak- 
ing it  a  period  of  large  receipts  of  gold  bullion  at 
the  mint,  and  that  the  San  Francisco  mint  makes 
returns  for  this  gold  in  gold  coin  or  New  York 
exchange  at  the  option  of  the  owner  of  the  bullion, 
tend  to  keep  New  York  exchange  at  par.  Exchange 
falls  rapidly  from  the  latter  part  of  October  to 
about  the  first  of  December,  when  it  reaches  the 
lowest  point  of  the  year.  Shipments  of  cash  be- 
tween San  Francisco  and  the  Eastern  States  are 
unimportant  during  this  period.  November  and 
December,  however,  are  the  months  of  largest 
transfers  of  cash  to  San  Francisco.  The  fall  in 
exchange  at  this  time  appears  to  be  due  primarily 
to  the  outward  movement  of  dried  fruits  and  to  the 
fact  that  this  is  the  active  part  of  the  northern  grain 
season.  The  low  point  of  the  year  is  reached  about 
the  last  week  in  November,  when  the  tax  collector 
for  the  city  and  the  county  of  San  Francisco  has 
been  accustomed  to  withdraw  large  sums  of  actual 
coin  from  circulation,  and  to  lock  much  of  it  up 
in  the  vaults  of  the  city  hall. 

166.  SEASONAL  VARIATIONS  IN  FOR- 
EIGN EXCHANGE.  —  Sterling  exchange  rates 
normally  rise  throughout  January  and  the  fore  part 
of  February.  Gold  movements  to  and  from  the 
United  States  at  this  time  are  generally  not  large, 
but  the  tendency  is  toward  exportation.  In  Lon- 


188        LOANS   AND    INVESTMENTS 

don  the  money  market  tends  to  be  reasonably 
strong  in  January,  weakening,  however,  in  Febru- 
ary. From  the  latter  part  of  February  until  the 
latter  part  of  March,  the  tendency  of  sterling  ex- 
change rates  is  slightly  downward.  March  is  a 
moderately  weak  month  in  the  London  money 
market.  Sterling  exchange  in  New  York  advances 
rapidly  from  the  latter  part  of  March  until  the 
middle  of  June,  reaching  its  highest  point  of  the 
year  in  June.  For  April,  May  and  June  the  move- 
ment of  gold  is  outward,  the  average  net  exporta- 
tions  reaching  their  highest  figures  for  the  year  in 
May  and  June.  The  London  market  appears  to 
"ease  up"  considerably  at  this  time.  Sterling  rates 
continue  high  through  July,  though  declining 
slighty,  and  then  decline  rapidly  under  the  influence 
of  cereal  and  cotton  bills  and  of  the  crop  moving 
demand  for  money,  until  they  reach  their  lowest 
point  of  the  year  about  the  first  week  of  October. 
The  months  of  October,  September  and  November 
(in  the  order  named)  are  the  months  of  largest 
net  gold  importations.  In  the  London  money  mar- 
ket the  fall  months  are  commonly  spoken  of  as  the 
period  of  the  "autumnal  pressure"  or  the  "autumnal 
drain."  From  the  fore  part  of  October  until  the 
latter  part  of  November,  sterling  exchange  tends 
to  move  upward,  and  from  the  latter  date  until  the 
end  of  the  year  it  is  very  uncertain.  Gold  importa- 
tions are  usually  much  smaller  in  December  than 
in  November.  Recent  important  developments  in 


LOANS   AND    INVESTMENTS        189 

the  use  of  finance  bills,  by  which  funds  are  bor- 
rowed by  American  bankers  in  Europe,  especially 
in  London,  on  collateral  security,  usually  in  the 
form  of  stocks  and  bonds,  have  had  an  important 
influence  upon  the  sterling  exchange  market,  tend- 
ing to  level  somewhat  the  seasonal  fluctuations.  It 
has,  however,  by  no  means  destroyed  the  normal 
seasonal  swing  of  the  exchange  market. 

167.  SEASONAL  VARIATIONS  IN  PRICES 
OF  BONDS.— On  theoretical  grounds  it  would  be 
expected  that  periods  of  greatly  increasing  demand 
for  money,  like  the  crop  moving  period,  would  tend 
to  cause  lower  prices  for  bonds,  and  that  a  period 
of  greatly  decreasing  demand,  like  that  of  mid- 
summer, would  tend  to  cause  higher  prices.  In  the 
fall  months  a  greater  burden  of  work  is  imposed 
upon  the  money  in  circulation,  and  unless  its  rate 
of  turnover  increases  the  same  amount  will  not  do 
the  work  except  at  a  lower  level  of  prices.  The 
extra  burden  of  exchange  work  is  carried  in  part 
by  the  expansive  power  of  deposit  currency,  but 
even  deposit  currency  must  be  supported  by  cash 
reserves,  and  the  need  of  cash  for  crop  moving 
purposes,  which  results  in  the  westward  and  south- 
ward movement  of  reserve  money,  limits  the  ex- 
pansive power  of  deposit  currency.  For  the  pur- 
pose of  testing  the  truth  of  such  reasoning,  "and 
interest"  quotations  were  compiled  and  index  num- 
bers computed  by  Professor  Kemmerer  for  the 
prices  of  twenty-seven  railroad  bonds  for  periods 


190        LOANS   AND   INVESTMENTS 

ranging  from  nine  to  nineteen  years.  These  figures 
were  then  combined  into  a  composite  for  all  bonds 
for  all  years,  each  point  in  the  composite  represent- 
ing three  hundred  and  ninety-three  or  three  hun- 
dred and  ninety-four  bond  years.  The  evidence 
afforded  by  these  figures  shows  the  following 
seasonal  tendencies: 

(1)  There  is  a  strong  tendency  for  bond  prices 
to  rise  from  the  beginning  of  the  year  until  about 
the  first  week  in  February,  a  period  during  which 
the  money  market  has  been  found  to  be  almost 
invariably  declining  and  weak.    From  the  first  to 
the  fifth  week  of  the  year  the  average  price  of  all 
twenty-seven  bonds  rose  from  98.99  to  99.79,  the 
average  index  number  of  prices  rising  from  48.1 
to  60.9.    For  twenty-six  of  the  twenty-seven  bonds 
the  average  price  was  higher  for  the  fifth  week  than 
for  the  first,  and  for  two  hundred  and  sixty-eight 
of  the  three  hundred  and  ninety-four  bond  years 
the  price  for  the  fifth  week  was  higher.    In  addition 
to  the  influence  of  the  weak  money  market  at  this 
period,  it  should  be  noted  that  after  January  (and 
also  July)  disbursements  of  interest  and  dividends, 
there  are  considerable  amounts  of  funds  seeking 
reinvestment. 

(2)  The  second  seasonal  period  extends  from 
the  fore  part  of  February  to  the  latter  part  of 
March.    It  is  a  period  during  which  the  tendency 
of  prices  is  downward,  and  a  period  of  increasing 
demand  for  loanable  capital.     The  average  price 


LOANS   AND   INVESTMENTS        191 

of  the  twenty-seven  bonds  fell  from  99.79  for  the 
fifth  week  to  99.02  for  the  eleventh  week,  the 
average  index  number  falling  from  60.9  to  51.1. 
For  twenty-five  of  the  twenty-seven  bonds  the 
average  price  was  lower  for  the  eleventh  week  than 
for  the  fifth,  and  the  price  was  lower  for  the  eleventh 
week  in  two  hundred  and  ninety  of  the  three  hun- 
dred and  ninety-four  bond  years. 

(3)  The  third  seasonal  tendency  is  for  bond 
prices  to  rise  from  the  latter  part  of  March  until 
the  fore  part  of  May,  and  to  be  comparatively  high 
from  then  until  about  the  middle  of  June — a  ten- 
dency in  substantial  harmony  with  the  money  mar- 
ket movements  of  this  season  of  the  year.    The 
average  price  of  the  twenty-seven  bonds  rose  from 
99.02   for   the   eleventh   week   to   99.56   for   the 
twenty-fourth  week,  the  average  index  number 
rising  from  51.1  to  56.7.    For  twenty-two  of  the 
twenty-seven  bonds  the  average  price  was  higher 
for  the  twenty-fourth  week  than  for  the  eleventh, 
and  of  the  three  hundred  and  ninety-three  bond 
years,  two  hundred  and  nine  showed  higher  prices 
for  the  twenty-fourth  week  than  for  the  eleventh. 

(4)  For  the  period  from  the  middle  of  June 
until    early    September   the    evidence   is   contra- 
dictory, but  on  the  whole  seems  to  point  to  a  ten- 
dency for  prices  to  be  moderately  high. 

(5)  Beginning  near  the  middle  of  September, 
bond  prices  tend  downward  until  about  the  middle 
of  October.    The  average  price  of  all  twenty-seven 


192        LOANS   AND   INVESTMENTS 

bonds  fell  from  99.49  for  the  thirty-sixth  week  to 
99.11  for  the  forty-first,  and  the  average  index 
number  fell  from  54.9  to  50.  For  twenty-one  of 
the  twenty-seven  bonds  the  average  price  was  lower 
for  the  forty-first  week  than  for  the  thirty-sixth, 
and  the  price  was  lower  for  the  forty-first  week 
in  two  hundred  and  thirty-six  of  the  three  hundred 
and  ninety-four  bond  years. 

(6)  From  about  the  middle  of  October,  after 
the  heaviest  part  of  the  crop  moving  demand  for 
money  is  over,  until  early  December,  bond  prices 
show  an  upward  tendency.  The  average  price  of 
all  bonds  rose  from  99.11  for  the  forty-first  week 
to  99.75  for  the  forty-ninth  week,  the  average  index 
number  rising  from  50  to  56.3.  Twenty-five  of  the 
twenty-seven  bonds  showed  higher  average  prices 
for  the  forty-ninth  week  than  for  the  forty-first, 
and  of  the  three  hundred  and  ninety-four  bond 
years,  two  hundred  and  forty-three  showed  a  higher 
price  for  the  forty-ninth  week.  In  addition  to  the 
relaxation  of  the  crop  moving  demand  for  money 
at  this  time,  another  factor  is  the  tendency  of 
dealers  to  accumulate  bonds  in  anticipation  of  an 
increasing  demand  rising  from  the  dividend  and 
interest  disbursements  of  January  1.  The  latter 
part  of  December  is  a  transitional  period  for  bond 
prices,  as  it  has  been  found  to  be  for  many  other 
money  market  phenomena,  the  tendency  being 
downward  from  the  forty-ninth  to  the  fifty-first 
week,  and  then  upward  for  the  fifty-second  week. 


LOANS   AND   INVESTMENTS        193 

The  average  price  of  all  twenty-seven  bonds  fell 
from  99.75  for  the  forty-ninth  week  to  99.39  for 
the  fifty-first  week,  and  then  rose  to  99.58  for  the 
fifty-second.  The  corresponding  average  index 
numbers  were,  respectively,  56.3,  52.2  and  55.  For 
twenty- three  of  the  twenty-seven  bonds  the  average 
price  was  lower  for  the  fifty-first  week  than  for  the 
forty-ninth.  The  price  was  lower  also  for  the  fifty- 
first  week  than  for  the  forty-ninth  in  two  hundred 
and  thirty-nine  of  the  three  hundred  and  ninety- 
four  bond  years.  The  tendency  toward  instability 
in  December  is  shown  by  the  fact  that  December 
had  both  more  maximum  annual  prices  and  more 
minimum  annual  prices  than  any  other  month  of 
the  year. 

It  may  be  concluded  that  the  extent  of  the  sea- 
sonal variations  in  bond  prices  is  usually  not  great, 
but  that  the  percentage  is  large  enough  in  the  abso- 
lute to  amount  to  many  million  of  dollars  annually. 
The  seasonal  movements  are  for  the  most  part  not 
very  pronounced  in  their  regularity,  but  on  the 
whole  tend  to  conform  to  the  normal  seasonal 
swing  of  the  money  market. 

168.  SEASONAL  STRAINS  ON  BANK  RE- 
SERVES.— Seasonal  demands  for  money  have  a 
direct  influence  on  bank  reserves.  The  enormous 
sum  of  twenty  billion  dollars,  more  or  less,  is  the 
sum  of  individual  deposits  in  American  banks, 
exclusive  of  savings  banks.  Of  this  large  sum 
approximately  one-half  consists  of  individual  de- 


194        LOANS   AND    INVESTMENTS 

posits  subject  to  check  without  notice.  Most  of 
the  remainder  consists  of  various  kinds  of  savings 
deposits,  a  considerable  part  of  which  are  legally 
payable  on  demand,  and  most  of  which  are  actually 
so  payable  as  a  matter  of  banking  policy  and  prac- 
tice. Such  total  individual  deposits  represent  over 
five  times  the  total  money  in  circulation,  while  that 
part  of  them  which  is  subject  to  withdrawal 
without  notice  represents  probably  at  least  three 
times  the  country's  total  monetary  circulation. 
The  obligation  of  banks  to  pay  their  demand 
deposits  on  demand  is  so  exacting  that  a  failure  to 
do  so  is  an  act  of  insolvency,  and  may  be  made  the 
occasion  of  forcing  the  guilty  bank  to  close  its 
doors.  As  regards  a  large  proportion  of  their  sav- 
ings deposits,  commercial  banks  may  legally  exer- 
cise the  privilege  of  requiring  thirty  or  sixty  days' 
notice  for  withdrawal.  They  seldom  do  so,  how- 
ever, since  refusal  to  pay  savings  deposits  on 
demand  impairs  public  confidence  in  any  bank,  and 
is  likely  to  cause  a  run  on  its  demand  deposits. 

169.  ADEQUACY  OF  RESERVES.— The  27,- 
000  commercial  banks,  holding  approximately  ten 
billion  dollars  of  demand  deposits,  according  to  re- 
cent statistics,  have  in  their  vaults  less  than  one  and 
a  half  billions  in  cash,  less  than  one-third  of  which  is 
"legal  tender  money."  Their  total  cash  reserves 
therefore  average  less  than  16  per  cent,  of  their  in- 
dividual deposits  subject  to  check  without  notice, 
and  but  7.6  per  cent,  of  their  total  individual  de- 


LOANS   AND   INVESTMENTS        195 

posits.  Subject  to  the  requirements  of  law,  which  in 
the  United  States  usually  compels  banks  to  keep  a 
certain  minimum  reserve  against  deposits,  and 
subject  also  in  some  cases  to  minimum  reserve 
rules  of  the  local  Clearing  House  Association,  each 
bank  must  decide,  according  to  the  nature  of  its 
own  business,  the  characteristics  of  its  own  cus- 
tomers— their  habits  and  prejudices — and  accord- 
ing to  the  varying  states  of  the  money  market,  how 
large  a  cash  reserve  it  will  keep.  Most  foreign 
countries  do  not  impose  by  law  minimum  reserve 
requirements  against  bank  deposits.  It  is  the 
almost  universal  practice,  however,  in  the  United 
States.  Such  requirements  have  been  imposed  by 
the  national  government  since  the  passage  of  the 
National  Banking  Act  in  1863,  and  are  also  imposed 
by  the  banking  laws  of  nearly  all  the  States.  Inas- 
much as  reserve  money  in  vaults  yields  no  direct 
profit  to  the  bank,  the  desire  for  profits  continually 
exercises  pressure  to  reduce  the  cash  reserves  to 
a  minimum.  On  the  other  hand,  profits  in  the  long 
run  require  that  the  bank  shall  enjoy  the  confidence 
of  the  public;  and  a  reputation  for  strength  and 
conservatism  is  to  a  bank  a  great  asset.  The  main- 
tenance of  a  reserve  at  all  times  fully  adequate  to 
meet  demands  is  a  large  factor  in  building  up  a 
bank's  reputation,  and,  as  many  American  bankers 
can  testify  after  a  period  of  money  stringency,  such 
a  reserve  is  an  important  factor  in  the  peace  of 
mind  of  bank  officials.  A  reserve,  however,  that 


196        LOANS   AND   INVESTMENTS 

would  be  adequate  for  one  bank  may  be  grossly 
inadequate  for  another;  while  a  reserve  that  is 
adequate  for  a  bank  at  one  season  of  the  year  may 
be  far  from  adequate  for  the  same  bank  at  another 
season. 

170.  LEGAL  TENDER  AND  OTHER  RE- 
SERVE CREDITS.— Bank  deposits  are  payable 
in  legal  tender  money,  and  legal  tender  money 
alone  if  the  depositor  insists.  Therefore,  narrowly 
speaking,  the  term  bank  reserve  might  be  limited 
to  legal  tender  money  in  the  possession  and  owner- 
ship of  the  bank.  Inasmuch,  however,  as  certain 
other  kinds  of  money,  e.  g.,  gold  certificates,  silver 
certificates,  National  bank  notes  and  Federal  Re- 
serve notes,  are  everywhere  accepted  by  the  public 
in  final  payment  of  debts,  and  are  redeemable  in 
legal  tender  money  on  demand,  by  an  institution 
of  unquestioned  financial  stability,  the  United 
States  Government,  it  is  reasonable  from  the  eco- 
nomic point  of  view — not  always  the  legal  point 
of  view — to  extend  the  term  to  cover  such  kinds 
of  money.  Furthermore,  in  countries  where  there 
is  a  central  bank,  as  in  France  and  Germany,  or 
a  group  of  central  banks  as  in  the  Federal  Reserve 
System  of  the  United  States,  with  liberal  powers 
of  bank  note  issue,  and  with  public  responsibilities 
in  the  line  of  rediscounting,  and  of  otherwise  con- 
serving the  national  money  market,  it  seems 
reasonable,  from  the  economic  point  of  view,  to 
extend  the  term  reserve  so  as  to  cover  not  only 


LOANS   AND   INVESTMENTS        197 

the  bank  notes  of  the  central  banks,  but  also 
bankers'  non-interest-bearing  demand  deposits  in 
these  central  banks.  In  France,  Germany  and 
England  bank  notes  of  the  central  bank  are  legal 
tender;  and  bank  reserves,  or  "cash  balances,"  as 
they  are  commonly  called,  always  mean  "cash  on 
hand  and  in  the  central  bank."  When  a  legal  mini- 
mum reserve  exists,  as  in  the  United  States,  it  is 
a  debatable  question  whether  it  is  sound  public 
policy  to  permit  bank  notes  and  bankers'  deposits 
in  the  central  bank  to  be  included  to  an  unlimited 
extent  in  the  funds  constituting  the  legal  minimum. 
171.  SECONDARY  RESERVES  AND 
THEIR  CHARACTER.— Having  decided  upon  the 
size  of  its  normal  reserves,  i.  e.,  a  fair  working 
balance  plus  a  reasonable  "factor  of  safety,"  the 
bank  seeks  to  invest  the  remainder  of  its  funds 
where  they  will  bring  the  largest  returns  consist- 
ent with  safety,  and  with  the  future  development 
of  the  bank's  business.  Since  the  great  bulk  of 
a  commercial  bank's  liabilities  to  its  customers  are 
demand  liabilities,  and  since  those  which  are  not 
demand  are  usually  payable  on  very  short  notice, 
i.  e.,  thirty  to  sixty  days,  the  bank  in  making  its 
investments  is  constrained  to  put  a  substantial  part 
of  its  funds  in  quick  assets,  investments  which  can 
be  turned  into  cash  promptly  and  without  much 
loss  in  time  of  need.  This  type  of  investment  is 
called  a  "secondary  reserve,"  because,  following 
the  cash  on  hand,  it  is  a  "second  line  of  defense" 


198        LOANS   AND    INVESTMENTS 

in  case  of  exceptional  demands.  Strictly  speaking 
it  is  not  a  "reserve"  at  all,  but  a  form  of  interest- 
yielding  investment.  These  secondary  reserves 
may  consist  of  innumerable  forms  of  investments ; 
they  may  be  interest-bearing  demand  deposits  in 
other  banks,  self-liquidating  commercial  paper  ar- 
ranged so  that  the  maturities  come  along  at  short 
intervals,  commodity  paper  secured  by  cotton,  grain 
or  other  staple  commodities,  call  or  time  loans  on 
stock  exchange  collateral;  securities  purchased, 
especially  listed  railroad  and  municipal  bonds,  and 
many  other  kinds  of  evidence  of  indebtedness. 
Whatever  form  these  investments  take,  the  banker 
in  selecting  them  submits  them  to  a  three-fold  test: 
(1)  Marketability  in  times  of  emergency,  (2)  Safety, 
and  (3)  Income  yield. 

172.  MARKETABILITY  IN  EMERGEN- 
CIES.— The  first  requirement  of  a  secondary  re- 
serve is  exchangeability  in  times  of  emergency 
for  money,  which  is  itself  the  ultimate  means 
of  payment  and  the  most  highly  exchangeable 
of  economic  goods.  The  emergencies  to  be  met 
may  be  runs  on  the  bank,  flurries  in  the  local 
money  market;  the  fairly  regularly  recurring 
periods  of  seasonal  strain,  like  the  crop  moving 
period  in  the  fall  or  the  period  of  the  "spring  re- 
vival;" or  it  may  be  one  of  the  great  financial  crises 
that  strike  us  occasionally.  Whatever  may  be  the 
cause  of  the  emergency,  the  secondary  reserve  is 
the  bank's  insurance  fund  to  protect  it  against  em- 


LOANS    AND    INVESTMENTS         199 

barrassment  and  insolvency.  When  the  demand 
comes,  if  the  secondary  reserve  can  be  turned 
quickly  into  cash,  i.  e.,  into  a  primary  reserve,  the 
bank  keeps  open  its  doors  and  conserves  its  reputa- 
tion; if  it  cannot  be  transmuted  quickly  into  cash, 
the  bank  suspends  cash  payments  and  usually  closes 
its  doors  either  temporarily  or  permanently.  Even 
if  later  it  meets  its  obligations  and  resumes  busi- 
ness, it  will  have  suffered  a  serious  impairment  in 
that  great  banking  asset,  reputation  for  financial 
stability.  The  secondary  reserve,  like  the  second 
line  of  defense  in  time  of  battle,  when  it  is  called 
upon  to  be  the  first  line,  is  first  of  all  expected  to 
meet  the  attack,  and  meet  it  effectively.  If  it  can 
do  so  without  serious  loss,  so  much  the  better,  but 
loss  or  no  loss,  it  should  meet  it.  To  this  end  it 
must  above  all  else  be  "emergency-marketable." 

173.  SAFETY  OF  INVESTMENT.  — It  is 
self  evident  that  a  bank's  secondary  reserves  should 
be  safely  invested.  Banks  want  interest,  but  they 
do  not  wish  to  lose  the  principal.  This  requirement 
of  safety  is  important  in  itself,  and  is  a  corollary 
of  the  preceding  requirement  of  marketability  in 
times  of  emergency.  For,  while  unsafe  and  specu- 
lative securities  may  have  active  markets  in  pros- 
perous times,  they  have  little  market  in  times  of 
crisis;  and  it  is  then  that  the  concerns  that  issue 
them  go  to  the  wall  in  large  numbers.  Not  all 
intrinsically  safe  securities  are  marketable  in 
stringent  times,  but  intrinsically  safe  securities 


200        LOANS    AND    INVESTMENTS 

alone  are  highly  marketable.  Only  assets  that  rest 
upon  "bed  rock"  values  can  be  depended  upon  as 
secondary  reserves. 

174.  INCOME  YIELD  OF  INVESTMENT. 
— In  order  of  importance  the  third  criterion  of  a 
good  secondary  reserve  is  income  yielding  capacity. 
Although  the  banking  business  is  in  a  large  measure 
"affected  with  a  public  interest,"  and  bankers  are 
in  a  high  degree  "public  trustees,"  it  is  still  true 
that  the  chief  motive  power  that  drives  the  modern 
banking  machinery  is  the  desire  for  financial  profit. 
A  secondary  reserve  is  primarily  an  emergency  in- 
vestment, but  it  is  none  the  less  an  investment,  and 
the   threatened   emergencies  which  influence   its 
character  are  of  infrequent  occurrence  and  usually 
of  brief  duration.  The  rate  of  "fair  weather"  profit, 
therefore,  is  an  important  consideration  even  in  the 
formation  of  a  secondary  reserve.     The  profits, 
however,  should  not  be  viewed  with  a  near-sighted 
vision.    It  is  as  true  of  secondary  reserve  invest- 
ments as  of  other  investments  of  bank  funds,  that 
the  successful  banker  is  the  man  with  foresight — 
the  banker  "with  a  telescope  in  his  head" — who 
often  passes  by  opportunities  for  good  immediate 
profits  in  order  to  seize  opportunities  to  strengthen 
and  broaden  his  clientele  for  future  business. 

175.  COMMERCIAL  PAPER  IN  EUROPE. 
— For  many  years  the  chief  secondary  reserve  in  the 
banks  of  Europe  has  been  commercial  paper,  princi- 
pally the  commercial  acceptance,  in  which  the  seller 


LOANS   AND   INVESTMENTS        201 

of  merchandise  draws  a  bill  of  exchange  on  the 
buyer  at,  say,  sixty  or  ninety  days'  sight,  the  buyer 
of  the  merchandise  accepting  the  bill,  and  later  pay- 
ing it  at  maturity  out  of  the  proceeds  of  the  sale  of 
the  merchandise.  The  seller  of  the  merchandise  ordi- 
narily discounts  this  paper  at  his  bank.  Such  com- 
mercial bills  bearing  the  names  of  large  and  reliable 
business  houses  become  ideal  secondary  reserves 
in  the  portfolios  of  banks.  They  bear  at  least  two 
names,  i.  e.,  that  of  the  drawer  and  that  of  the 
drawee,  and  often  in  addition  the  name  of  one  or 
more  endorsers.  They  normally  carry  on  their 
face,  or  on  documents  attached,  evidence  of  a  com- 
mercial transaction  which  is  closed;  the  drawee, 
i.  e.,  the  buyer  of  the  goods,  having  accepted  them 
and  obligated  himself  to  pay  for  them  a  definite  sum 
of  money  at  a  specified  date.  These  bills  are  ordin- 
arily drawn  for  current  merchandising  transactions 
and  bear  evidence  that  they  are  not  for  capital 
investments.  They  are  self  liquidating  in  that  the 
sale  of  the  goods  by  the  drawee  provides  the  funds 
with  which  to  pay  the  bill,  and  in  that  the  goods 
are  ordinarily  turned  over  rapidly.  In  view  of  the 
fact  that  it  is  the  drawers  of  the  bills  (i.  e.,  the 
sellers  of  the  merchandise)  who  discount  them  at 
the  bank,  not  the  drawees  (i.  e.,  the  buyers  of  the 
merchandise  and  the  ones  who  are  to  pay  the  bills), 
and  of  the  further  fact  that  the  bills  often  pass 
through  several  hands  in  the  open  market  before 
their  maturity,  these  bills  usually  are  paid  promptly. 


202        LOANS   AND    INVESTMENTS 

High  grade  paper  of  this  kind  is  always  acceptable 
for  rediscount  at  the  great  central  banks  of  Europe, 
and  the  proceeds  of  the  rediscounting  operation, 
when  left  on  deposit  or  taken  in  the  form  of  bank 
notes,  serve  as  primary  reserves.  The  great  central 
banks  feel  a  public  moral  responsibility  to  rediscount 
at  their  official  discount  rates  such  paper  in  practi- 
cally unlimited  quantities  when  the  public  interest 
seems  to  demand  it.  The  fact  that  this  paper  is  re- 
discountable  at  the  central  bank  makes  it  also  sal- 
able in  the  open  market,  with  the  result  that  good 
grade  commercial  bills  in  many  parts  of  Europe  are 
in  time  of  peace  almost  as  dependable  in  emergencies 
as  is  cash  in  vault.  A  bank  with  a  reasonable  amount 
of  such  bills  in  its  portfolio  has  an  ideal  secondary 
reserve. 

176.  SITUATION  IN  FRANCE.— Upon  this 
subject  a  brief  reference  to  the  testimony  given 
to  members  of  the  National  Monetary  Commission 
by  bankers  in  France  will  be  useful.  Officers  of 
the  Credit  Lyonnais,  one  of  the  leading  banks  of 
France,  testified  as  follows : 

Question — "Does  the  Bank  of  France  rediscount 
bills  for  the  other  banks  in  France?" 

Answer — "The  Bank  of  France  rediscounts  all 
bills  when  the  person  presenting  the  bill  is  admitted 
to  discount  and  when  the  bills  have  the  necessary 
three  signatures,  have  less  than  three  months  to 
run,  and  are  payable  in  cities  where  the  bank  has 
a  branch.  It  is  not  legally  obliged  to  discount  all 


LOANS   AND    INVESTMENTS        203 

bills  presented,  but,  as  a  matter  of  fact,  nobody  has 
ever  complained  of  its  way  of  proceeding." 

Question — "You  regard  that  item  of  bills  dis- 
counted as  your  practical  reserve  because  of  your 
ability  to  rediscount  the  bills  at  the  Bank  of 
France? 

Answer — "Yes;  bills  discounted  and  cash  are, 
for  an  establishment  such  as  ours,  the  most  essen- 
tial part  of  our  liquid  assets." 

The  founder  of  the  Credit  Lyonnais  declared 
that  if  the  Bank  of  France  did  not  exist  he  would 
close  the  Credit  Lyonnais  in  times  of  crisis.  Ac- 
cording to  the  estimate  of  the  Governor  of  the 
Bank  of  France,  about  70  per  cent,  of  the  paper 
held  by  the  bank  bore  the  signature  of  some  bank 
as  one  of  the  endorsers. 

177.  SITUATION  IN  OTHER  EUROPEAN 
COUNTRIES.  — A  similar  situation  exists  in 
Germany  and  most  other  continental  European 
countries  as  regards  the  dependence  of  the  com- 
mercial banks  upon  the  central  bank  for  obtaining 
emergency  funds  by  rediscounting  commercial 
paper.  In  England  the  situation  is  somewhat 
different  in  that  the  joint-stock  banks  rarely  re- 
discount at  the  Bank  of  England.  However,  these 
banks  loan  funds  extensively  to  discount  and  brok- 
erage houses,  and,  when  pressure  comes  for  funds, 
they  call  these  loans,  with  the  result  that  the  dis- 
count and  brokerage  houses  resort  to  the  Bank  of 
England  for  funds.  Indirectly,  therefore,  the  result 


204        LOANS   AND   INVESTMENTS 

is  much  the  same  as  on  the  continent.  Reserve 
money  in  England  is  "cash  on  hand  and  in  the  Bank 
of  England,"  and  the  statements  of  most  banks 
do  not  differentiate  the  two  items.  The  Bank  of 
England  always  stands  ready  to  rediscount  prime 
commercial  paper  and  transmute  it  into  reserves. 
In  Europe  generally,  therefore,  prime  commercial 
paper  is  the  chief  dependence  for  a  secondary  re- 
serve, and  it  meets  in  a  high  degree  the  three  re- 
quirements of  a  good  secondary  reserve,  viz., 
"emergency  marketability,"  safety,  and  good  in- 
come yield. 

178.  SITUATION  IN  THE  UNITED 
STATES.— The  situation  in  the  United  States  is 
very  different,  although  recent  developments  under 
the  Federal  Reserve  System  are  slowly  changing 
the  American  situation  in  the  direction  of  that  of 
Europe.  In  the  United  States,  commercial  paper, 
which  consists  chiefly  of  one  name  promissory 
notes,  has  not  until  recently  been  very  satisfactory 
as  a  secondary  reserve.  The  absence  of  any  central 
bank  in  this  country  for  a  couple  of  generations  prior 
to  1914,  denied  to  American  banks  the  privilege  of 
a  practically  unlimited  market  for  the  rediscount 
of  this  commercial  paper,  a  privilege  which  has  so 
long  been  enjoyed  by  European  banks.  Further- 
more, the  provisions  of  our  National  Banking  Law 
denying  to  National  banks  the  privilege  of  estab- 
lishing branches,  and  provisions  in  the  banking 
laws  of  many  of  our  States  either  prohibiting  en* 


LOANS   AND   INVESTMENTS        205 

tirely  the  establishment  of  branches  by  State  banks, 
or  imposing  heavy  restrictions  upon  their  establish- 
ment, has  prevented  the  growth  in  this  country 
of  many  large  banks.  Our  bond-secured  bank  note 
system  has  been  another  inhibiting  influence. 
America  is  unique  among  the  advanced  countries 
of  the  world  in  its  great  number  of  small  and  inde- 
pendent banks,  the  chief  business  of  most  of  which 
is  limited  to  a  small  community.  There  accord- 
ingly developed  no  large  commercial  banks  which 
could  be  depended  upon  to  provide  a  wide  market 
for  the  discount  of  commercial  paper.  The  Na- 
tional Bank  Act  as  interpreted  by  the  courts  pre- 
vented National  banks  from  accepting  time  bills 
drawn  upon  them,  and  bank  acceptances  were  not 
permitted  under  the  banking  laws  of  most  of  the 
States.  Accordingly,  prior  to  the  inauguration  of 
the  Federal  Reserve  System,  the  bank  acceptance, 
which  is  such  a  highly  marketable  type  of  paper 
in  Europe,  was  almost  unknown  in  this  country. 
Aside  from  the  paper  of  a  few  large  business 
houses,  which  in  recent  years  has  been  widely 
marketed  throughout  the  country  by  note  brokers, 
American  commercial  paper  was  essentially  local 
paper. 

179.  LACK  OF  COMMERCIAL  PAPER 
MARKET.— Nothing  that  could  be  called  prop- 
erly a  commercial  paper  market  existed  in  the 
United  States.  A  petty  amount  of  rediscounting, 
it  is  true,  was  done  for  country  banks  by  a  few 


206        LOANS   AND    INVESTMENTS 

large  banks;  also  a  considerable  amount  of  direct 
loaning  to  small  banks  on  their  customers'  paper 
as  collateral.  But  there  was  no  broad  and  depend- 
able market  in  which  banks  could  always  secure 
funds  on  their  unmatured  commercial  paper  in 
times  of  emergency.  Furthermore,  one  name 
promissory  notes,  unlike  the  commercial  accept- 
ances so  common  in  Europe,  are  not  self  liquidat- 
ing paper.  The  notes  are  usually  discounted  at 
the  payer's  own  bank,  i.  e.,  the  bank  where  the 
purchaser  of  the  goods  keeps  his  account;  not,  as 
so  commonly  in  Europe,  at  the  payee's  bank,  i.  e., 
the  bank  in  which  the  seller  of  the  goods  keeps  his 
account.  They  are  accordingly  often  renewed  and 
the  borrowers  are  naturally  averse  to  having  their 
notes  pass  out  of  the  hands  of  their  friendly  local 
bank,  and  into  the  hands  of  strangers.  American 
business  men  in  the  past  have  strenuously  objected 
to  having  their  paper  "hawked  about  from  bank 
to  bank,"  and  the  practice  of  rediscounting  with 
another  bank,  when  known,  was  looked  upon  as 
a  sign  of  weakness.  For  these  and  other  reasons 
American  commercial  paper  was  essentially  non- 
liquid  paper.  It  could  not  be  realized  upon  until 
maturity,  and  often  not  then.  It  lacked  the  most 
fundamental  requirement  of  a  secondary  reserve — 
"emergency  marketability"  American  bankers  were 
accordingly  compelled  to  turn  to  bonds  for  their 
secondary  reserves. 

180.    BONDS  AS  SECONDARY  RESERVES. 


LOANS    AND    INVESTMENTS        207 

— Although  State  banks  in  a  number  of  States 
are  permitted  to  invest  in  stocks,  the  National 
Banking  Law  as  interpreted  by  the  courts  does 
not  permit  National  Banks  to  own  stocks,  except 
to  protect  themselves  from  loss  in  the  case  of 
loans  previously  made.  The  authority  to  invest 
in  bonds  is  enjoyed  throughout  the  country  by 
State  banks,  and  although  not  expressly  granted 
by  the  National  Banking  Act,  has  been  held  by  the 
courts  to  be  implied  in  the  power  to  carry  on  busi- 
ness by  discounting  and  negotiating  promissory 
notes,  drafts,  bills  of  exchange,  and  other  evidences 
of  debt.  As  a  matter  of  fact,  National  banks  have 
invested  in  bonds  other  than  United  States  Govern- 
ment bonds  from  the  beginning  of  the  National 
banking  system  in  1863.  There  has  been  an  in- 
crease in  the  National  banks'  investment  holdings 
of  such  securities  since  the  inauguration  of  the 
Federal  Reserve  System.  This  increase,  prob- 
ably of  little  permanent  significance,  because  of 
the  confused  conditions  of  business  during  the 
early  part  of  the  war  period,  and  because  the 
release  of  hundreds  of  millions  of  reserve  money 
through  the  reduction  in  the  legal  reserve  require- 
ments of  National  banks,  and  the  offering  of  lib- 
eral facilities  for  rediscount  through  the  opening 
of  the  Federal  Reserve  banks,  released  large 
amounts  of  bank  funds  at  a  time  when  the  bond 
market  was  particularly  favorable  because  of  the 
offering  at  attractive  rates  of  big  blocks  of  Ameri- 


208        LOANS   AND   INVESTMENTS 

can  securities  by  the  people  of  belligerent  Europe. 
According  to  the  latest  figures  available  the 
security  holdings  of  loan  and  trust  companies  are 
slightly  larger  than  those  of  National  banks,  while 
those  of  State  banks  are  about  one-third  as  large 
as  those  of  National  banks. 

181.  SECONDARY  RESERVES  UNDER 
THE  FEDERAL  RESERVE  SYSTEM.— What- 
ever may  have  been  the  utility  of  bonds  in  the  past 
as  secondary  reserves  for  commercial  banks,  a  new 
situation  has  been  created  by  the  Federal  Reserve 
System.  The  twelve  Federal  Reserve  banks  provide 
liberal  facilities  for  rediscount  throughout  the  coun- 
try, A  broad  interpretation  of  those  provisions  of 
the  Federal  Reserve  Act  which  describe  the  kinds 
of  paper  that  can  be  rediscounted,  has  been  made  by 
the  Federal  Reserve  Board.  The  Board  has  also 
made  a  liberal  interpretation  of  the  open  market 
provisions  of  the  act,  bank  acceptances  and  trade 
acceptances  are  being  given  preferential  discount 
rates  by  the  Federal  Reserve  banks,  and  their  use 
is  being  slowly  extended.  An  open  discount  market 
is  developing.  American  commercial  paper  is  losing 
its  rigidity  as  a  bank  asset,  and  also  its  provincial- 
ism; it  is  becoming  liquid  and  national.  The  Fed- 
eral Reserve  authorities,  leading  bankers,  mer- 
chants, and  economists  are  doing  much  to  level  up 
the  character  of  our  commercial  paper.  Banks  with 
a  good  grade  of  such  paper  in  their  portfolios  can 
now,  for  the  first  time  in  our  history,  be  absolutely 


LOANS   AND   INVESTMENTS        209 

certain  of  their  ability  to  turn  such  paper  into  cash 
either  by  sale  in  the  open  market  or  by  rediscount 
with  a  Federal  Reserve  bank.  These  privileges,  to- 
gether with  the  provision  of  the  Federal  Reserve 
Act  that  after  three  years  from  the  opening  of  the 
Federal  Reserve  banks,  only  cash  in  vault  and  on 
deposit  with  the  Federal  Reserve  bank  can  be 
counted  by  a  member  bank  as  legal  reserve,  appear 
destined  to  induce  commercial  banks  to  place  an 
increasing  part  of  their  demand  deposits  in  com- 
mercial paper. 

182.  BUSINESS  CYCLES.  — In  addition  to 
seasonal  variations,  business  is  affected  by  longer 
periods  of  alternating  depression  and  activity. 
Such  alternations  follow  one  another  at  irregular 
intervals,  and  have  become  known  as  "business 
cycles."  Nobody  can  predict  exactly  the  length 
of  any  period  of  activity  or  the  length  of  any 
period  of  depression.  Such  periods  in  the  past 
have  been  of  varying  duration,  and  have  been 
characterized  by  similar  phenomena,  as  follows: 

(1)  Beginning  with  a  period  of  depression,  there  is  a 
gradual  recovery,  and  business  reaches  a  stage  of  what  may 
be  called  normal  activity.  From  the  normal  stage  business 
may  develop  into  a  condition  of  abnormal  activity,  culminat- 
ing in  a  crisis.  The  crisis  itself  may  be  accompanied  by  a 
panic  or  not,  but  invariably  a  period  of  depression  follows 
any  crisis.  Banks  are  not  mainly  responsible  for  these 
changes,  for  banking  operations  rather  reflect  than  create 
business  conditions ;  but  the  banking  business  is  deeply  con- 
cerned with  alternations  between  depression  and  activity. 


210        LOANS   AND   INVESTMENTS 

When  business  is  inactive  the  trend  of  commodity  prices  is 
downward,  and  profits  are  small,  if  there  are  any  profits  at 
all.  The  demand  for  capital  is  relatively  small,  including 
the  demand  for  bank  loans.  Banks  at  such  times  commonly 
find  that  they  could  lend  a  good  deal  more  than  solvent 
borrowers  want.  At  such  a  period  there  is  a  good  deal  of 
business  house  cleaning.  Weak  concerns  are  weeded  out, 
and  those  that  stand  the  strain  are  forced  to  put  into  use 
every  device  that  will  lessen  the  cost  of  production.  A  per- 
iod of  depression,  therefore,  may  be  regarded  from  many 
points  of  view  as  creating  the  conditions  necessary  for  more 
prosperous  times. 

(2)  What  brings  about  a  revival  in  business  activity? 
It  is  a  little  difficult  to  say,  but  usually  it  would  seem  to  be 
something  which  stimulates  particular  branches  of  business. 
It  may,  for  example,  be  the  active  demand  in  foreign  coun- 
tries for  American  agricultural  products.  If  such  a  demand 
comes,  and  there  happen  to  be  good  harvests  in  this  country, 
obviously  at  least  one  class  in  the  community  gets  a  large 
and  satisfactory  return  for  its  endeavors.  The  demand  for 
other  commodities  from  the  agricultural  sections  of  the 
country  would  in  such  circumstances  unquestionably  in- 
crease. Improved  conditions  in  agriculture  would  have  an 
effect  which  would  be  felt  to  a  greater  or  lesser  extent 
throughout  the  whole  range  of  industry.  This  demand  would 
be  greater  in  some  branches  than  it  would  be  in  others.. 
It  might  be  particularly  great  for  agricultural  implements. 
This  increased  demand  for  agricultural  implements  would  in 
turn  create  an  increased  demand  for  iron  and  steel  products ; 
and,  again,  the  increased  prosperity  in  agricultural  sections 
of  the  country  would  presumably  extend  to  the  railroads  and 
increase  their  demand  for  products.  The  increased  demand 
thus  spread  to  these  other  lines  of  business  would  in  turn 
from  them  react  back  once  more  over  the  entire  industrial 
field,  and  thus  by  a  process  of  induction,  so  to  speak,  each 


LOANS   AND    INVESTMENTS        211 

kind  of  business  would  act  and  react  upon  all  kinds  of  busi- 
(niess  in  a  favorable  way.  People  would  in  such  circum- 
stances begin  to  feel  a  bit  more  optimistic  about  the  future. 
Wholesalers,  jobbers  and  retailers  would  begin  to  stock  up 
more  largely  with  all  kinds  of  commodities  in  which  they 
deal.  Financial  conditions  would  be  favorable  to  the  advance, 
because  in  a  period  of  financial  depression  the  demand  for 
capital  is  relatively  small,  including  the  demand  for  short- 
time  loans.  All  conditions,  then,  are  favorable  to  the  expan- 
sion of  business  in  case  a  profitable  demand  arises  for  addi- 
tional products  of  industry.  A  period  of  recovery  has  then 
been  reached. 

(3)  With  the  advent  of  business  activity  an  increased 
number  of  people  are  willing  to  invest  additional  capital  for 
an  expected  future  demand.  A  willingness  manifests  itself 
to  extend  railroads,  to  enlarge  factories  or  build  new  fac- 
tories, to  construct  additional  office  buildings,  etc.,  and  for 
the  time  being  no  difficulty  is  encountered  in  securing  capital 
for  such  enterprises.  This  construction  work  necessarily 
creates  an  increased  demand  for  the  production  of  industries 
which  supply  material  for  construction  purposes,  notably 
the  iron  and  steel  industry.  Prices  now  begin  to  advance 
and  perhaps  advance  rather  rapidly.  This  further  increases 
business  activity  for  the  time  being,  for  when  prices  advance 
profits  immediately  increase,  and  for  a  very  natural,  simple 
reason.  Wages  and  salaries  do  not  move  up  very  rapidly, 
not  nearly  so  rapidly  as  prices  of  most  commodities  may 
move.  Naturally,  therefore,  the  advantages  from  advance 
in  prices  goes  to  those  persons  who  own  the  current  prod- 
ucts of  industry.  The  persons  who  own  the  current  products 
of  industry  are  the  active  business  men  and  the  sharehold- 
ers in  corporations.  Increased  profits  naturally  stimulate 
further  enterprises,  further  construction  and  further  invest- 
ments designed  to  supply  additional  commodities  of  all 
sorts.  Now  the  demand  for  capital  may  begin  to  outstrip 


212        LOANS   AND    INVESTMENTS 

current  savings.  Rates,  not  only  for  short-time  loans  but 
for  capital  which  is  to  be  invested  for  long  periods,  begin  to 
advance,  but  the  business  man  is  perfectly  ready  to  pay 
these  higher  rates,  because  his  profits,  owing  to  higher 
prices,  are  unusually  large. 

(4)  This  is  the  situation  of  affairs  during  a  period  of 
activity  which  becomes  a  period  of  normal  business  activity. 
When  prices  are  moving  upward  profits  are  large,  and  errors 
of  judgment  are  particularly  likely  to  be  made  in  the  invest- 
ment of  additional  capital.  The  assumption  is  made  that 
profits  will  remain  at  their  existing  high  level  or  perhaps 
reach  a  still  higher  point.  Less  care  is  exercised  in  such 
circumstances  in  making  investments,  and  the  willingness 
to  pay  fancy  prices  for  the  capital  which  is  secured  is 
marked.  Moreover,  after  a  time,  wages  do  begin  to  advance, 
and  even  salaries  may  move  up  a  little,  though  they  are  the 
last  to  be  affected.  The  upward  movement  of  wages  may 
be  more  rapid  after  a  while  than  the  further  upward  move- 
ment of  prices,  although  on  the  whole  that  does  not  seem 
to  be  the  case.  From  the  study  of  price  statistics  and  wage 
statistics  it  does  not  appear  that  in  the  year  or  two  of  abnor- 
mal activity  preceding  a  crisis  wages  in  general  have  been 
moving  up  more  rapidly  than  prices.  The  serious  cause  for 
trouble  in  the  labor  situation  is  to  be  found  elsewhere.  The 
increased  activity  of  business  necessarily  means  full  employ- 
ment for  everybody  and  competition  for  workmen  and  a 
larger  amount  of  overtime.  The  results  are  higher  costs  of 
production.  Men  are  taken  on  rapidly,  and  the  average 
efficiency  of  the  men  is  lowered,  partly  because  men  are 
naturally  not  so  efficient  when  they  know  they  can  with 
perfect  ease  get  another  equally  good  and  perhaps  better 
position,  partly  because  of  inadequate  training,  since  busi- 
ness is  so  active  that  there  is  not  time  to  train  the  newer 
men  taken  on,  and  partly  because  of  overstrain.  Men  can 
work  overtime  for  a  short  period  without  affecting  their  effi- 


LOANS   AND    INVESTMENTS        213 

ciency,  but  a  good  deal  of  overtime  is  bound  to  lessen  the 
average  output  per  hour  of  the  workman.  All  of  these 
elements  tend  to  increase  the  labor  cost  of  production 
toward  the  close  of  active  business,  and  all  of  these  are  fac- 
tors quite  independent  of  the  amount  of  wages  paid. 

(5)  In  a  period  of  very  active  business,  also,  there  is  less 
time  to  devise  and  put  into  operation  further  arrangements 
for  lessening  cost.  The  thing  which  seems  important  is  to 
get  out  product  and  get  it  out  as  rapidly  as  possible.  Just 
because  profits  have  been  large,  business  men  are  prepared 
to  take  more  risks.  They  are  prepared  to  extend  their  opera- 
tions unduly  on  the  capital  which  they  themselves  have 
invested  in  their  business.  They  trust  that  everything  will 
come  out  all  right,  even  though  they  allow  a  good  many 
bills  payable  to  accumulate ;  and  even  though  they  are  grant- 
ing more  and  more  credit  to  their  customers.  Balance  sheets 
show  an  increased  amount  of  receivables,  and  an  increased 
amount  is  borrowed  on  short  time.  When  the  supply  of 
capital  available  for  long-time  investment  becomes  a  scarc- 
ity, when  it  becomes  difficult  to  float  issues  of  bonds,  or  to 
secure  money  through  additional  preferred  or  common 
stock,  a  business  which  is  expanding  its  operations  is  likely 
to  attempt  to  do  so  on  the  basis  of  an  increased  amount  of 
short-time  credit.  Now  a  concern  which  has  borrowed  a 
large  amount  on  short  time  is  in  a  very  vulnerable  position. 
If  anything  happens  which  delays  collections  very  much,  or 
if  anything  happens  to  banks  which  makes  them  desire  to 
contract  loans,  such  an  overextended  business  gets  into  diffi- 
culties. Moreover,  if  anything  happens  which  tends  to  check 
the  upward  movement  of  prices,  which  causes  profits  to  de- 
cline, it  will  have  a  serious  effect  upon  such  a  business,  for 
after  all  one  of  the  considerations  taken  into  account  in 
granting  short  time  credit  is  the  high  earning  power  of  the 
borrowing  concern.  If  it  is  evident  that  the  earning  power 
is  lessened,  banks  may  be  inclined  to  curtail  loans. 


214        LOANS   AND   INVESTMENTS 

(6)  All  the  conditions,  therefore,  tend  to  become  unfav- 
orable in  a  period  of  general  business  activity.  The  situation 
becomes  one  in  which  comparatively  slight  disturbing 
influences  may  cause  a  collapse.  It  is,  however,  impossible 
to  predict  just  when  a  collapse  will  come.  Sometimes  the 
business  situation  changes  slowly  from  one  of  business 
activity  to  one  of  depression,  without  any  striking  or  dra- 
matic circumstances.  That  is,  however,  not  the  rule.  As  a 
rule,  a  crisis  marks  the  transition  between  business  activity 
and  business  depression.  At  the  end  of  a  period  of  very 
active  business,  an  exceptionally  large  number  of  concerns 
are  in  a  position  where  anything  which  lowers  their  earning 
power,  or  which  delays  the  payment  to  them  for  what  they 
have  sold,  will  put  them  into  difficulties.  These  difficulties 
may  be  only  temporary,  if  the  earning  power  is  good,  but 
whether  they  are  temporary  or  permanent  the  immediate 
effect  is  pretty  much  the  same — it  weakens  the  banks,  it 
destroys  confidence  in  the  immediate  future  of  business,  and 
brings  home  to  people  generally  that  it  is  highly  probable 
that  over  all  the  field  of  industry  there  are  presumably  many 
weak  and  overextended  concerns.  When  people  begin  to 
feel  this  way  about  the  situation,  they  naturally  cancel  all 
plans  for  future  investment  which  they  can  by  any  means 
cancel.  Plans  for  construction  work  of  all  sorts  are  given 
up,  and  the  demand  for  the  various  materials  which  go  into 
construction  work  falls  off.  Prices  drop,  and  with  the  fall 
of  prices  profits  drop,  and  many  concerns  which  were  based 
upon  the  assumption  that  profits  would  continue  at  the  rate 
at  which  they  were  when  those  enterprises  were  started  go 
to  the  wall.  Then  is  seen  the  beginning  of  a  period  of  depres- 
sion once  more,  which  after  a  time  will  be  used  for  another 
business  house  cleaning.  Crises  may  degenerate  into  panics 
or  they  may  not,  and  it  does  not  depend  so  much  upon  the 
severity  of  the  crisis  as  it  does  upon  the  character  of  the 
banking  system.  When  a  crisis  comes  on,  people  engaged  in 


LOANS   AND   INVESTMENTS        215 

business  attempt  to  strengthen  themselves  against  a  storm. 
They  do  it  in  two  ways — by  deferring  payments  to  others 
and  by  seeking  to  get  paid  by  others  and  seeking  to  borrow 
from  banks.  The  demand  for  accommodation  from  the 
banks  is  invariably  increased  when  a  crisis  comes  along. 
The  proceeds  of  such  loans  are  commonly  not  used,  but  are 
wanted  as  a  sort  of  insurance  or  backlog. 

(7)  Under  such  circumstances,  the  contraction  of  loans 
by  banks  not  only  makes  the  general  business  situation  for 
the  moment  more  unsatisfactory,  but  it  also  lessens  public 
confidence  in  the  banks  and  leads  people  to  withdraw  money 
from  the  banks,  thus  still  further  strengthening  the  tendency 
of  the  banks  to  force  contraction.  In  our  various  crises  this 
course  has  been  followed  until  panic  conditions  have  been 
created,  and  until  the  banks  have  realized  that  it  was  impos- 
sible to  insist  upon  further  contraction  because  it  would 
involve  general  ruin.  The  banks  have  then,  when  forced  by 
panic  conditions,  continued  loans  and  have  also  sometimes 
suspended  cash  payments.  In  other  countries,  and  it  is 
hoped  in  this  country  under  the  Federal  Reserve  System,  the 
contraction  of  loans  in  crises  is  not  insisted  upon  simply  for 
the  purpose  of  strengthening  the  banks.  It  is  hoped  that 
there  will  be  sufficient  cash  and  credit  available  so  that  loans 
will  not  be  contracted  at  such  times,  but  that  a  sufficient 
increase  in  loans  will  be  made  to  meet  the  needs  of  the  busi- 
ness community.  If  we  get  such  conditions  crises  will  not  in 
the  future  in  this  country  degenerate  into  panics. 


CHAPTER  VI 

International  Exchange 

183.  FOREIGN  EXCHANGE.  — Foreign  ex- 
change is  the  business  which  is  concerned  with  the 
buying  and  selling  in  one  country  of  rights  to 
money  in  other  countries,  available  either  immedi- 
ately or  in  the  future,  for  the  purpose  of  settling 
debts  incurred  in  the  broad  transactions  of  inter- 
national commerce.    The  business  seems  commonly 
to  be  regarded  as  a  very  mysterious  subject,  one 
beset  with  innumerable  complications.     The  gen- 
eral principles  of  the  subject  are,  however,  by  no 
means  abstruse.     The  conduct  of  a  foreign  ex- 
change department  requires  special  training  and 
a  certain  natural  ability;   but  any  intelligent  per- 
son can  readily  obtain  an  understanding  of  the 
subject,  and  such  an  understanding  is  of  much 
value   to   those    engaged    in    other    branches    of 
banking. 

184.  DOMESTIC    EXCHANGE.— Much  for- 
eign exchange  business  is  closely  akin  to  certain 
kinds  of  domestic  business  carried  on  by  all  banks, 
such  as  making  payments  and  collections  between 
different  parts  of  the  country.    In  this  particular 
domestic  exchanges  are  closely  analogous  to  for- 
eign exchanges.    Domestic  exchange  rates  rise  and 
fall  within  limits  which  are  set  by  the  plentif ulness 
or  scarcity  of  drawable  funds  in  financial  centers 

216 


LOANS   AND    INVESTMENTS        217 

or  by  the  cost  of  shipping  currency  between  any 
two  places.  The  quotations  are  usually  expressed 
in  a  premium  or  discount  on  a  purchase  or  sale  of 
$1,000.  If  it  costs,  for  example,  50  cents  to  ship 
$1,000  between  two  places,  the  rate  of  exchange 
may  be  up  to  50  cents  above  or  below  par,  depend- 
ing upon  the  effect  of  supply  and  demand  upon 
the  funds  utilized. 

185.  DEMAND  RATES  OF  EXCHANGE.— 
Foreign  exchange  demand  rates  fluctuate  in  es- 
sentially the  same  way.     They  move  above  and 
below  par  to  the  gold  export  or  gold  import  point, 
and  these  export  and  import  points  are  determined 
by  the  cost  of  shipping,  not  currency,  but  gold. 
Quotations  are,  however,  expressed  in  a  different 
manner,  because  of  the  differences  in  the  monetary 
units  of  different  countries.     It  would  be  incon- 
venient to  express  foreign  exchange  rates  in  the 
terms  used   for   domestic   exchange,   although  it 
would  be  possible. 

186.  MINT    PAR    OF    EXCHANGE.  —  The 
basis  of  exchange  between  two  systems  of  coinage 
is  known  as  the  mint  par  of  exchange,  and  is  de- 
scribed as  the  rate  at  which  the  standard  coin  of 
one  country  is  convertible  into  the  standard  coin 
of  another  in  accordance  with  mint  laws.     This 
basis  of  exchange  can  only  be  effective  between 
countries  having  the  same  standard  of  value.    As 
an  example,  the  English  sovereign  is  by  law  made 
to  weigh  123.27447  grains  troy  or  7.98805  grammes 


218        LOANS   AND   INVESTMENTS 

of  gold  eleven-twelfths  fine.  The  United  States 
ten  dollar  gold  piece,  the  golden  eagle,  is  by  law 
made  to  weigh  258  grains  of  gold,  nine-tenths  fine. 
To  find  the  mint  par  between  the  two  coins,  the 
following  method  is  used: 

Question — How  many  dollars  equal  one  pound? 

If  the  weight  of  one  pound  equals  123.274  grains 
standard  gold — 

If  standard  gold  of  12  grains  equals  11  grains 
of  fine  gold — 

If  fine  gold  of  232.2  grains  equals  10  dollars — 
1  X  123.274  X  11  X  10 

=  $4.8665 

1  X  12  X  232.  2 

Mint  par  is — One  pound  equals  4.8665  dollars. 

187.  STERLING  EXCHANGE.  —  If  it  costs, 
for  example,  in  normal  times,  $2.50  to  ship  $1,000 
in  gold  to  England,  then  $2.50  sets  the  limit  to 
the  possible  fluctuation  in  sight  exchange.     The 
par  of  exchange  between  the  United  States  and 
England  is  $4.8665  and  the  exchange  rates  fluctu- 
ate above  and  below  this  figure  by  the  cost  of  ship- 
ping gold  to  England.    Such  cost  is  usually  at  5 
per  mille,  or  .024  cents.    This  added  to  the  mint 
par  of  exchange  is  dollars  4.89,  which  we  may 
assume  to  be  the  limit  beyond  which  the  American 
debtor  will  not  go  in  buying  exchange  on  London 
for  gold  will  then  be  shipped  to  settle  debts.    This 
limit  is  known  as  a  gold  or  specie  point. 

188.  FRENCH  EXCHANGE.— In  the  case  of 


LOANS   AND   INVESTMENTS        219 

France  the  quotation  is  expressed  in  a  different 
manner.  Instead  of  being  expressed  in  United 
States  money  it  is  expressed  in  francs — in  the 
number  of  francs  which  the  gold  in  the  dollar  will 
make.  The  gold  in  a  dollar  will  make  five  francs 
eighteen  and  one-eighth  centimes  (francs  5.18J4). 
Exchange  on  Paris  therefore  fluctuates  above  and 
below  this  point  by  the  cost  of  shipping  gold  to 
Paris. 

189.  GERMAN   EXCHANGE.— Exchange  on 
Berlin,  like  that  on  London,  is  expressed  in  United 
States  money,  but  instead  of  using  the  mark,  four 
marks  are  made  the  basis  of  the  quotation.    The 
gold  in  four  marks  coined  into  dollars  makes  ninety- 
five  and  three-sixteenths  cents   (cents  95  3/16). 
Consequently  German  exchange  may  rise  above 
and  fall  below  this  point  by  the  amount  that  it 
costs  to  send  gold  to  Berlin.    Changes  in  Paris  and 
Berlin  rates  are  usually  quoted  in  fractions,  1/8, 
1/16,  and  1/32,  while  sterling  exchange  is  quoted 
to  four  points  of  decimals. 

190.  SIGNIFICANCE    OF    CHANGES    IN 
EXCHANGE  QUOTATIONS.— When  exchange 
is  expressed  in  United  States  currency,  a  rising 
quotation  indicates  an  approach  towards  the  export 
point.    It  also  indicates  a  demand  for  remittances 
which  is  in  excess  of  the  supply.    When,  however, 
quotations  are  expressed  in  the  currency  of  a  for- 
eign country,  the  opposite  is  true.    A  fall  in  the 
quotations  then  indicates  an  approach  to  the  export 


220        LOANS   AND    INVESTMENTS 

point.  For  example,  a  payment  of  one  thousand 
pounds  is  to  be  made  in  London.  If  exchange  is 
near  the  export  point  more  will  be  paid  than  if  it 
is  near  the  import  point,  for  at  the  export  point 
the  gold  value  of  the  sovereign  plus  the  cost  of 
shipping  will  be  paid.  If  the  rate  were  $4.88,  more 
would  be  paid  to  send  one  thousand  pounds  to 
London  than  if  the  rate  were  $4.86.  But  suppose 
it  is  desired  to  pay  one  thousand  francs  in  Paris. 
Clearly  more  will  be  paid  if  only  5  francs  16  cen- 
times are  obtainable  for  a  dollar  than  if  5  francs 
18  centimes  for  a  dollar  were  obtainable. 

191.  EXPORT  AND  IMPORT  POINTS.— 
The  expenses  incurred  in  shipping  gold  determine 
the  export  and  import  points,  or  gold  or  specie 
points  as  they  are  known.  The  obvious  expenses 
are  freight,  insurance,  commission  and  the  cost 
of  packing  the  gold.  All  these  elements  of  expense 
are  somewhat  variable.  Freight  charges  may  not 
be  uniform,  and  it  makes  a  difference  as  to  the 
kind  of  gold  available  for  shipment.  The  most 
inexpensive  form  for  the  purpose  is  gold  in  bars. 
Bars  can  be  packed  more  handily,  are  of  full  weight, 
and  there  is  less  loss  from  abrasion  than  in  the 
case  of  shipments  of  coin.  Gold  bars  are  secured 
from  the  United  States  Treasury  at  a  constant 
charge  of  4  cents  per  $100.  In  the  past  it  has  not 
always  been  possible  to  get  an  adequate  supply  of 
bars,  but  in  the  future  this  difficulty  will  probably 
not  present  itself,  because  the  Government  has 


LOANS   AND    INVESTMENTS        221 

been  empowered  to  hold  gold  in  the  form  of  bars 
against  gold  certificates.  Formerly  all  the  gold 
thus  held  was  coined.  The  export  point  will  at 
times  in  the  future  be  a  little  lower  than  in  the 
past,  because  of  this  possibility  of  securing  gold 
bars. 

192.  VARIABLE  PRICES  OF  GOLD.— The 
great  European  central  banks  have  a  sliding  scale 
of  rates  for  gold,  buying  bars  and  foreign  coin  at 
coinage  value  as  a  maximum  price  and  at  that 
price  less  the  loss  of  interest  during  the  period 
required  for  coinage  as  a  minimum  price.    In  sell- 
ing gold  they  impose  rates  which  offset  in  varying 
degree  the  advantage  of  shipping  bars  or  foreign 
coin  rather  than  more  or  less  worn  domestic  coin. 
By  these  means  the  importation  of  gold  is  at  times 
stimulated,  or  its  exportation  obstructed,  but  the 
influence  is  slight  and  temporary.    In  the  long  run 
they  have  no  appreciable  influence  upon  the  dis- 
tribution of  the  precious  metal  throughout  the 
world. 

193.  TIME     FACTOR    IN     GOLD     SHIP- 
MENTS.— A  very  important  element  of  expense 
in  gold  shipments  is  time.    If  a  fast  express  steamer 
is  sailing  the  import  point  is  nearer  par  than  during 
a  week  when  only  the  slower  boats  are  available. 
This  is  a  factor,  however,  only  influencing  imports. 
When  $1,000,000  of  gold  is  exported  sight  exchange 
can  at  once  be  sold  to  an  equivalent  amount.    The 
exporter  has  his  money  at  once.    Suppose,  how- 


222        LOANS   AND    INVESTMENTS 

ever,  it  is  a  case  of  imported  gold.  The  importer 
loses  the  interest  the  money  would  have  earned  in 
London  while  the  gold  is  in  transit,  consequently 
the  gold  import  point  is  somewhat  further  away 
from  par  than  the  gold  export  point.  If  we  assume, 
for  example,  that  at  a  given  moment  the  gold  ex- 
port point  to  London  is  about  iy2  cents  above  par, 
then  we  would  probably  find  that  the  gold  import 
point  was  something  like  2  cents  below  par,  the  dif- 
ference being  increased  or  diminished  as  foreign 
interest  rates  rose  or  fell.  It  should  also  be  noted 
that  foreign  central  banks  frequently  allow  immedi- 
ate credit  for  gold  while  in  transit.  This,  of  course, 
brings  the  export  point  still  nearer  the  par  of 
exchange.  There  has  been  a  slow  but  steady  re- 
duction in  the  possible  range  of  demand  exchange 
fluctuation.  Twenty  or  thirty  years  ago  the  export 
point  to  London  was  above  $4.89.  It  is  now 
normally  in  the  neighbourhood  of  $4.88.  The  im- 
port point  was  then  in  the  vicinity  of  $4.83.  It  is 
now  normally  above  $4.84.  But  from  what  has  been 
said  it  will  be  seen  that  the  exact  point  at  which  it 
is  possible  to  export  or  import  gold  at  a  profit  is 
subject  to  much  variation  even  within  short  periods 
of  time. 

194.  CABLE  TRANSFERS.— The  cable  trans- 
fer rate  is  always  above  the  demand  rate.  It  gives 
the  purchaser  the  amount  of  his  purchase  immedi- 
ately, whereas  in  the  case  of  demand  exchange  the 
proceeds  will  not  be  placed  to  his  credit  until  the 


LOANS   AND    INVESTMENTS        223 

steamer  arrives  on  the  other  side  six  to  ten  days 
later.  The  seller  of  cable  transfers  loses  interest 
on  the  amount  of  his  sales  at  once,  since  his  bal- 
ances in  the  foreign  banks,  which  uniformly  draw 
interest  are  at  once  reduced.  The  interest  rate  on 
these  balances  is  not,  however,  constant.  There 
is  a  varying  spread  between  the  cable  transfer  rate 
and  the  demand  rate.  If,  for  instance,  a  foreign 
exchange  dealer  is  getting  iy2%  upon  his  balance 
in  London  at  one  time,  and  at  another  time  is  get- 
ting 2%,  he  will  naturally  charge  more  for  a  cable 
transfer  in  the  second  case  than  he  would  in  the 
first.  There  are  also  special  causes  for  fluctua- 
ton  in  cable  transfers.  It  sometimes  happens  that 
many  persons  defer  making  necessary  remittances 
in  expectation  that  rates  will  go  down  at  the  last 
moment.  They  must  meet  their  engagements  on 
the  other  side,  and  the  demand  at  such  times  for 
cable  transfers  may  cause  the  rate  to  move  ab- 
normally far  from  the  demand  rate. 

195.  RATES  ON  TIME  BILLS.— A  glance  at  a 
newspaper  will  show  that  in  addition  to  cable  trans- 
fer and  demand  rates  there  are  a  variety  of  other 
rates  generally  quoted — bankers'  bills  and  various 
kinds  of  commercial  bills  drawn  for  varying  periods 
of  time.  Rates  for  these  bills  are  always  lower 
than  demand  rates.  If  it  was  found  that  the  de- 
mand rate  on  London  was  $4.86  it  might  also  be 
found  that  the  rate  on  bankers'  60-day  bills  was 
$4.83,  and  it  might  be  found  that  the  rate  on  a 


224        LOANS   AND    INVESTMENTS 

certain  class  of  commercial  bills  was  $4.82*4  and 
on  another  kind  $4.82.  The  quotations  on  time 
bills  are  less  than  those  for  demand  exchange  by 
the  amount  of  the  varying  costs  of  discounting 
them  in  the  foreign  country  on  which  they  are 
drawn,  and  by  the  stable  costs  of  commissions  and 
stamp  taxes.  If  the  rate  of  discount  on  a  60-day 
banker's  bill  is  3%  in  London,  then  the  quotation 
for  a  bill  of  similar  kind  in  New  York  will  be  the 
sight  rate  of  exchange  less  the  discount  and  other 
charges  on  the  bill  in  London.  Should  the  discount 
rate  in  London  advance  on  that  particular  kind  of 
bill,  then  the  quotation  will  move  somewhat  farther 
away  from  the  sight  rate.  The  reason  for  the 
different  prices  or  quotations  for  the  various  kinds 
of  time  bills  is  that  there  is  a  scale  of  discount 
rates  in  the  London  market  dependent  upon  the 
character  of  the  bill.  The  lowest  rate  prevails  on 
bills  drawn  for  acceptance  on  a  London  bank  or 
acceptance  house.  There  are  usually  various  other 
rates  increasing  up  to  the  "bank  rate,"  which  is 
the  rate  of  discount  of  the  Bank  of  England. 

196.  CLASSIFICATION  OF  TIME  BILLS. 
— Bills  without  clocuments,  known  as  clean  bills, 
are  usually  marketed  by  drawers  of  well  known 
and  established  credit.  Most  foreign  trade  gives 
rise  to  documentary  bills  of  exchange.  The  seller 
draws  a  bill  of  exchange  upon  the  purchaser,  or 
upon  the  bank  of  the  purchaser,  attaching  to  the 
bill  various  documents,  the  most  important  being 


LOANS   AND    INVESTMENTS        225 

the  bill  of  lading,  without  which  it  is  impossible  to 
secure  possession  of  the  goods.  Documentary  bills 
are  of  two  kinds,  documentary  for  payment  and 
documentary  acceptance  bills.  In  documentary 
payment  bills  the  purchaser  of  the  goods  can  not 
get  possession  of  them  until  he  has  paid  the  bill 
of  exchange.  These  payment  bills,  again,  may  be 
classified  as  those  drawn  against  sales  of  perish- 
able goods  and  such  other  goods  as  the  purchaser 
is  fairly  certain  to  want  immediately  upon  arrival, 
and  those  drawn  in  connection  with  goods  which 
the  purchaser  may  not  want  until  the  bill  matures. 
If  the  purchaser  desires  the  goods  immediately 
and  makes  payment,  he  is  allowed  a  rebate,  which, 
in  the  case  of  English  bills,  is  1%  below  the  cur- 
rent Bank  of  England  rate.  Therefore  the  maxi- 
mum price  of  such  bills  is  the  sight  rate  of  exchange, 
less  the  rebate  and  the  ordinary  commission  and 
stamp  tax.  If  the  goods  are  of  a  kind  which  are 
not  likely  to  be  wanted  by  the  purchaser  until 
maturity  of  the  bill  of  exchange,  then  the  dealer" 
purchasing  the  bill  may  be  obliged  to  hold  it  until 
maturity.  If  he  does  not  care  to  finance  the  trans- 
action during  the  life  of  the  bill  it  cannot  be  dis- 
counted, because  the  purchaser  of  the  goods  may 
at  any  time  exercise  his  right  of  taking  up  the 
bill.  The  exchange  dealer  may,  however,  use  such 
bills  as  collateral,  drawing  his  own  bill  upon  his 
foreign  correspondent. 
197.  DOCUMENTARY  ACCEPTANCE 


226        LOANS   AND   INVESTMENTS 

BILLS. — Documentary  acceptance  bills  are  of  two 
kinds — those  which  are  drawn  for  acceptance  on  a 
merchant,  and  those  which  are  similarly  drawn  on 
a  bank  or  acceptance  house.  Naturally  the  latter 
command  the  better  rate,  because  the  acceptors 
are  universally  known.  Documentary  acceptance 
bills  on  merchants  are  regularly  discounted  at  a 
slightly  higher  rate  in  London,  and  consequently 
the  price  of  such  a  bill  in  this  country  will  be 
slightly  lower  than  documentary  bills  on  London. 
For  this  reason,  to  an  increasing  extent  the  bank 
acceptance  is  displacing  the  commercial  bill  in 
foreign  trade  throughout  the  world.  The  importer, 
for  example,  secures  an  acceptance  credit  for  some 
definite  amount  with  a  well  known  bank  in  his  own 
or  some  other  country.  He  then  instructs  his  agent, 
or  those  from  whom  he  purchases  goods,  to  draw 
bills  accompanied  by  shipping  documents  upon  the 
accepting  bank.  Similarly  the  exporter  may  draw 
bills  on  banks  in  his  own  or  in  some  other  country 
with  which  his  customers  have  established  ac- 
ceptance credits. 

198.  ARBITRAGE.— Arbitrage  is  the  utiliza- 
tion of  all  the  principal  financial  centers  of  the 
world  for  the  purpose  of  purchasing  in  the  cheapest 
markets  exchange  to  cover  the  obligations  of 
definite  transactions.  A  New  York  banker  sells 
a  60-day  bill  on  London.  To  meet  this  bill  at 
maturity  he  may  cause  Dutch,  French  or  Russian 
bills  on  London  to  be  remitted  to  that  city  for  his 


LOANS   AND    INVESTMENTS        227 

account,  always  using  in  largest  volume  those  bills 
which  are  procured  most  cheaply.  Such  transac- 
tions maintain  the  equilibrium  of  the  world's  prin- 
cipal exchanges.  The  dealer  in  arbitrage  is  very 
similar  to  the  stock  broker  who  specializes  in  cer- 
tain stocks  and  uses  all  the  bourses  of  the  world 
to  make  his  deliveries  as  cheaply  as  possible  to  the 
advantage  of  his  profit  account.  Arbitrage  re- 
quires specialization  and  is  a  distinctive  field. 

199.  FINANCE  BILLS.— The  finance  bill  is 
an  instrument  of  foreign  exchange  connected  in 
largest  measure  with  speculative  transactions.  It 
is  a  bill  drawn  by  a  banker  on  a  correspondent 
banker.  A  stock  exchange  firm  is  desirous  of  mak- 
ing a  loan  to  complete  a  speculative  transaction  in 
which  it  is  engaged.  Under  the  ordinary  method 
of  procedure  it  places  with  its  banker  acceptable 
collateral,  with  a  margin  of  20%,  and  gives  a  note 
for  the  amount  desired.  v  The  banker  negotiating 
the  loan,  in  order  to  make  the  amount  of  the  loan 
again  available  for  his  use,  draws  a  60  or  90-day 
bill  upon  his  foreign  correspondent,  usually  one 
in  London,  which  he  sells  in  the  New  York  market. 
When  this  bill  arrives  in  London  it  is  accepted  by 
the  banker  upon  whom  it  is  drawn  and  funds  are 
provided  at  maturity  for  its  cancellation.  Often- 
times another  bill  of  similar  kind  is  drawn  to  pro- 
vide for  the  payment  of  the  one  maturing.  A  free 
use  of  this  instrument  would  cause  American  ex- 
change on  London  to  cheapen. 


228        LOANS   AND   INVESTMENTS 

200.  REVOLVING    CREDIT.— Most  credits 
opened  for  the  purpose  of  enabling  exporters  to 
obtain  payment  for  goods  when  ready  for  shipment 
can  be  made  into  revolving  credits.     There  are 
three  forms  of  revolving  credit:   (a)  The  exporter 
is  accorded  the  privilege  of  drawing  drafts  in  an 
amount  outstanding  at  any  one  time  of  $10,000, 
for  example,  which  drafts  are  drawn  as  the  goods 
are  ready  for  shipment.    When  the  full  amount  of 
the  established  credit  is  exhausted  no  drafts  can 
then  be  drawn  until  any  or  all  of  the  outstanding 
drafts  are  paid,  at  which  time  the  amount  of  the 
paid  drafts  again  becomes  available  to  be  drawn 
against,  provided,  always,  that  the  amount  of  the 
credit  as  originally  established  is  not  exceeded; 
(b)  A  credit,  for  example,  is  established  for  $10,000. 
It  is  to  be  drawn  against  in  one  draft.    When  the 
draft  so  drawn  has  been  paid  the  full  amount  of  the 
credit  is  again  available;   (c)   A  credit,  for  ex- 
ample, is  established  for  $10,000.    It  is  to  be  drawn 
against  in  one  amount.     When  such  a  draft  has 
been  drawn,  the  full  amount  is  again  available  to 
be  drawn  against.    This  is  practically  a  credit  for 
an  unlimited  amount. 

201.  TRAVELERS'  LETTERS  OF  CREDIT. 
— Travelers'  letters  of  credit  are  widely  used  and 
very  generally  known.    They  are  at  once  a  letter 
of  introduction,  and  also  a  request  from  one  banker 
to  other  bankers  in  business  relationship  with  him 
to  accord  courtesies  to  and  to  pay  to  the  holders 


LOANS   AND   INVESTMENTS        229 

thereof  a  sum  of  money  in  amount  not  to  exceed 
the  amount  provided  for  in  the  letter.  The  issuing 
banker  obligates  to  hold  himself  liable  for  drafts 
drawn  under  the  terms  of  the  letter,  and  for  this 
he  usually  charges  a  commission  on  the  amount 
of  the  letter  of  credit.  If  the  letter  is  to  be  used 
throughout  the  world  an  authenticated  book  con- 
taining a  list  of  correspondents  who  will  cash 
drafts  thereunder  is  given  the  holder  of  the  letter 
of  credit.  A  letter  so  issued  is  termed  a  circular 
letter  of  credit.  When  a  letter  is  available  in  cer- 
tain centers  only,  the  issuance  of  such  letter  is 
especially  advised  to  the  banker  upon  whom  it  is 
made  available  and  signatures  of  the  holder  are 
forwarded  at  the  same  time. 

202.  EUROPEAN  FINANCING  OF  AMERI- 
CAN FOREIGN  TRADE.  — The  United  States, 
like  other  rapidly  developing  countries,  has  not  in 
the  past  financed  any  appreciable  amount  of  its 
foreign  trade,  either  of  exports  or  of  imports.    De- 
mands for  capital  within  the  country  have  been  so 
great  that  rates  for  loans  have  regularly  been  above 
those  in  European  money  centres,  and  especially  in( 
London.    London,  and  to  the  same  extent  other 
European  money  markets,  have,  therefore,  financed 
not  only  the  trade  between  Europe  and  the  rest  of 
the  world,  but  also  trade  between  non-European 
countries. 

203.  FINANCING  OF  IMPORTS.  — Let  us 
take,  for  example,  the  case  of  an  importation  of 


230        LOANS   AND    INVESTMENTS 

wool  to  the  United  States  from  Australia.  The 
most  common  way  of  arranging  payment  has  been 
through  the  commercial  letter  of  credit  on  a  Lon- 
don bank.  Let  us  suppose  that  a  Boston  wool 
house  is  about  to  purchase  a  cargo  of  wool.  It  will 
secure  through  some  foreign  exchange  banker  in 
this  country  an  acceptance  credit  with  some  Lon- 
don bank.  Under  the  terms  of  this  credit,  the 
agent  in  Australia  of  the  Boston  wool  house  will 
be  empowered  to  draw  documentary  acceptance 
bills  up  to  a  certain  amount  on  the  London  bank. 
Upon  the  purchase  of  the  wool  a  bill  on  the  Lon- 
don bank  is  drawn,  and  with  shipping  documents 
attached  it  is  sold  to  some  Australian  bank.  Thus 
the  funds  are  provided  with  which  to  pay  for  the 
wool.  The  Australian  bank  sends  the  bill  with 
documents  to  its  London  correspondent,  and  at  the 
same  time  ordinarily  will  sell  an  equivalent  amount 
of  sight  exchange  against  the  credit  which  it  will 
secure  in  London  through  the  discount  of  the  docu- 
mentary bill.  No  one  in  Australia  has  any  further 
connection  with  this  transaction.  The  correspond- 
ent of  the  Australian  bank  in  London  takes  the  bill 
with  its  documents  to  the  London  bank  on  which 
it  is  drawn  for  acceptance.  Having  been  accepted 
by  the  London  bank,  which  takes  the  shipping 
documents,  the  bill  is  discounted  in  the  open  market 
by  the  London  agent  of  the  Australian  bank.  This 
provides  funds  to  meet  the  sight  exchange  which 
the  Australian  bank  had  sold.  The  London  bank 


LOANS    AND    INVESTMENTS        231 

which  accepted  the  bill  then  sends  the  documents 
to  this  country  to  the  foreign  exchange  banker 
through  whom  the  arrangement  was  made  or  per- 
haps to  a  shipping  broker.  The  wool  house  can  not 
get  possession  of  the  wool  until  it  can  get  the  bill, 
and  the  exchange  banker  need  not  give  up  this 
document  until  he  is  provided  with  funds  sufficient 
to  purchase  the  sight  exchange  on  London  neces- 
sary to  meet  the  payment  of  the  bill  accepted  by  the 
London  bank.  Thus  everyone  is  secured  at  each 
stage  in  the  transaction,  in  so  far  as  the  bill  itself 
may  be  regarded  as  security. 

204.  FINANCING  OF  EXPORTS.  —  Here 
let  us  take  the  case  of  a  shipment  of  goods  from 
United  States  to  South  America.  The  financing 
is  handled  in  a  number  of  different  ways,  but 
one  of  them  will  serve  for  illustrative  purposes. 
A  commission  house  exporting  goods  to  South 
America  will  commonly  be  paid  in  90-day  drafts 
on  some  London  bank,  drawn  by  the  South  Ameri- 
can purchaser  of  the  goods.  If  the  commission 
house  waits  until  these  bills  mature,  it  will  be  a 
long  time  out  of  its  money — the  time  that  the 
goods  are  in  transit  to  South  America,  the  time 
that  is  required  in  sending  the  bill  of  exchange  to 
London,  and  90  days  thereafter.  Something  like 
six  months  will  elapse  before  the  maturity  of  the 
bill.  But  the  commission  house  in  New  York  wants 
its  money  at  once.  It  may  itself,  therefore,  draw  a 
90-day  bill  upon  a  London^  bank  and  get  the  cash 


232        LOANS   AND    INVESTMENTS 

by  selling  this  bill  in  the  New  York  market.  This 
90-day  bill  will  be  sent  to  London  and  discountedi 
in  the  London  market.  Thus  it  will  be  seen  that 
London  really  finances  the  shipment  of  goods  from 
New  York  to  South  America.  When  the  90-day 
bill  falls  due  the  New  York  house  must  provide 
payment,  since  the  South  American  bill  is  not  yet 
due.  This  it  can  manage  by  discounting  the  South 
American  bill  in  the  London  market.  Finally, 
when  this  bill  matures,  means  of  payment  will  have 
been  provided  by  the  South  American  purchaser 
of  the  goods.  Thus  during  the  period  of  six  months 
London  has  financed  the  transaction;  first,  by  dis- 
counting the  bill  of  the  New  York  commission 
house,  and  then  by  discounting  the  bill  drawn  by 
the  South  American  purchaser. 

205.  FOREIGN  EXCHANGE  DEPART- 
MENTS. —  A  considerable  number  of  banks 
throughout  the  country  have  established  foreign 
exchange  departments  in  recent  years.  They  have 
entered  into  the  necessary  arrangements  with 
foreign  banks,  establishing  balances  with  them,  and 
are  thus  able  to  provide  their  customers  directly 
with  cable  transfers,  sight  drafts,  and  also  letters 
of  credit,  both  travellers'  and  commercial.  A  for- 
eign exchange  department  of  this  kind  does  not 
require  any  considerable  amount  of  capital.  It  can 
be  conducted  on  a  small  margin.  Indeed,  so  far  as 
the  ordinary  bank  is  concerned,  it  is  quite  feasible 
for  the  foreign  exchange  department  to  clean  up 


LOANS   AND   INVESTMENTS        233 

every  day.  It  will  purchase  time  bills  of  exchange 
drawn  against  merchandise  shipments,  which  it  can 
secure  either  from  New  York  or  direct  at  the  rate 
at  which  these  bills  on  receipt  will  be  discounted  in 
London  or  elsewhere.  It  therefore  incurs  no  risk 
from  fluctuations  in  foreign  rates  of  discount — 
fluctuations  which  the  American  banker  would 
hardly  be  in  position  to  forecast.  Having  pur- 
chased time  bills  at  a  rate  which  is  less  than  the 
demand  rate  of  exchange  by  the  amount  of  the 
discount  on  arrival,  stamp  tax  and  commission, 
the  bills  may  be  at  once  sent  on  for  discount,  andi 
at  the  same  time  the  foreign  exchange  department 
may  sell  an  equivalent  amount  of  demand  ex- 
change. Of  course,  if  the  foreign  exchange  man- 
ager cares  to  take  a  risk,  he  need  not  sell  demand 
exchange  equivalent  to  his  purchases  of  time  bills; 
but  if  he  has  not  very  much  capital  to  work  with, 
and  wishes  to  avoid  practically  all  risk  from  fluctua- 
tions in  exchange  rates,  it  is  ordinarily  possible 
to  do  so. 

206.  HOW  THE  DEMAND  RATE  OF  EX- 
CHANGE IS  DETERMINED.— The  many  banks 
scattered  all  over  the  country  which  have  foreign 
exchange  departments  do  not  directly  have  any- 
thing to  do  with  the  determination  of  the  sight 
rate  of  exchange.  That  rate  is  determined  by  the 
operations  of  a  comparatively  small  number  of 
dealers  in  exchange  in  New  York  City.  Some  of 
them  are  private  banking  firms,  and  others  are  the 


234        LOANS   AND    INVESTMENTS 

managers  of  foreign  exchange  departments  of 
banks  and  trust  companies.  These  institutions  and 
firms  necessarily  incur  a  certain  amount  of  risk 
in  connection  with  foreign  exchange  dealings. 
They  buy  and  sell  a  more  or  less  indefinitely  large 
amount  of  sight  exchange.  If  it  is  believed  by  one 
of  them,  taking  into  consideration  all  of  the  various 
inferences,  that  rates  are  going  down,  he  will  be 
likely  to  offer  a  good  sized  block  of  sight  exchange, 
and  if  another  takes  the  opposite  view  he  will  be 
prepared  to  buy.  Dealings  between  the  large  for- 
eign exchange  houses  are  reflected  in  constant  vari- 
ations in  the  demand  rate  of  exchange.  Sometimes 
the  exchange  market  is  quiet,  but  at  times  it  is  in 
a  feverish  condition.  Those  who  are  engaged  in 
the  foreign  exchange  business  in  New  York  must 
takeiaccount  of  every  influence  which  may  increase 
or  diminish  the  amount  of  foreign  exchange  ma- 
terial. What  may  be  called  the  foreign  exchange 
material  consists  in  the  first  place  of  all  sorts  of 
time  bills  drawn  against  or  resulting  from  exports 
and  imports  of  merchandise.  All  of  the  com- 
mercial bills  drawn  against  cotton  shipments, 
grain,  petroleum  shipments,  etc.,  build  up  balances 
on  the  other  side  against  which  exchange  may  be 
sold.  Interest  payments,  shipping  charges,  tourist 
expenses,  dealings  in  securities,  issues  of  American 
securities  marketed  abroad  or  resold  to  this 
country,  all  provide  foreign  exchange  material. 
207.  INTERNATIONAL  BORROWING.— 


LOANS   AND    INVESTMENTS        235 

In  addition  to  all  these  exchange  creating  factors, 
there  are  temporary  loans  made  by  one  foreign 
market  in  another  foreign  market.  These  may  be 
made  in  a  variety  of  different  ways.  The  foreign 
exchange  house  in  New  York  enjoying  good  credit 
may  for  example  draw  bills  upon  a  London  cor- 
respondent payable  in  three  months.  These  bills, 
on  acceptance  by  the  London  correspondent,  may 
be  readily  discounted,  thus  giving  the  American 
exchange  house  a  balance  to  the  amount  of  the 
bills,  and  enabling  it  to  sell  an  equivalent  amount 
of  sight  exchange  in  New  York.  This  is  what 
ordinarily  happens  in  the  case  of  foreign  borrow- 
ing. No  actual  money  commonly  moves  between 
the  two  markets.  Similarly,  borrowing  may  be 
arranged  by  an  exchange  dealer  for  one  of  his 
clients  who  may  deposit  collateral  as  security. 
Sometimes  the  initiative  may  be  taken  by  a  for- 
eign banker  who  desires  to  lend  in  this  market. 
Profit  on  these  foreign  loans  is  largely  determined 
by  the  course  of  the  sight  exchange  rate.  Suppose, 
for  example,  that  the  sight  rate  of  exchange  is  $4.86, 
and  that  a  long  bill  is  drawn  and  sold  at  $4.82,  a 
difference  reflecting  the  discount  rate  on  London. 
When  the  long  bill  matures,  the  borrower  must 
purchase  sight  exchange  with  which  to  take  it  up. 
If  the  sight  exchange  rate  is  then  still  at  $4.86  he 
will  have  paid  only  four  cents  on  each  pound  for 
the  use  of  the  money  during  the  period.  But  in  the 
event  that  the  sight  rate  has  gone  up  to  $4.87  his 


236        LOANS   AND    INVESTMENTS 

loan  is  more  costly,  as  he  will  be  paying  five  cents 
for  each  pound.  These  foreign  short  time  loans  do 
not  ordinarily  occasion  movements  of  money  into 
the  borrowing  country,  but  they  frequently  check 
gold  exports.  They  are  seldom  made  except  when 
the  rate  of  exchange  is  high — toward  the  export 
point.  Let  us  suppose  that  the  rate  in  New  York 
for  three  months'  collateral  loans  is  5%,  and  that 
the  discount  rate  in  London  is  3%.  It  may  then  be 
advantageous  to  borrow  in  London  if  the  sight  rate 
is  at  least  as  high  as  $4.87.  It  can  not  go  much 
above  $4.88,  and  it  may  be  at  a  much  lower  point 
three  months  hence,  when  it  becomes  necessary  to 
purchase  demand  exchange.  If  the  rate  does  go 
down,  it  reduces  the  cost  of  the  loan  to  the  bor- 
rower. If,  however,  he  should  enter  upon  this 
transaction  when  the  sight  exchange  rate  was  $4.85, 
he  would  incur  the  risk  of  a  possible  advance  to 
$4.88,  making  the  loan  an  extremely  costly  affair. 
208.  LOANS  BY  FOREIGN  BANKS.— The 
foreign  lender  may  be  willing  to  take  the  risk  of 
fluctuations  in  the  sight  exchange  rate.  If  so  he 
lends  in  currency.  Suppose,  for  example,  that  the 
quotation  on  banker's  time  bills  is  $4.83,  and  that 
some  one  in  New  York  wishes  to  borrow  $500,000. 
The  bill  is  drawn  for  say  £100,000  on  London  by 
the  New  York  agent  of  the  London  bank,  acting 
on  instructions.  The  bill  is  sold  for  $4.83,  and  the 
proceeds  are  turned  over  to  the  borrower  in  New 
York;  that  is,  he  gets  $483,000.  When  the  bill  ma- 


LOANS   AND   INVESTMENTS        237 

tures,  the  borrower  must  return  $483,000,  plus  what- 
ever rate  of  interest  has  been  agreed  upon,  let  us 
say  5%.  The  borrower  is  not  affected  by  fluctua- 
tions in  sight  exchange.  But  now  the  foreign  lender 
may  desire  to  get  back  his  money  in  London.  He 
instructs  his  correspondent  to  buy  sight  exchange 
on  London.  If  the  demand  rate  has  gone  down, 
then  the  London  bank  gains  from  having  assumed 
the  risk.  If  the  sight  rate  is  down  to  $4.85,  for  in- 
stance, it  can  buy  sight  drafts  on  London  for 
£100,000  for  $485,000.  It  gets  the  benefit  of  the 
higher  return.  If  the  sight  rate  were  $4.87,  it 
would  be  obliged  to  pay  $487,000  in  order  to  get  its 
money  back  in  London.  When  the  foreign  banker 
is  inclined  to  think  that  the  rate  on  sight  exchange 
is  going  down,  he  will  be  willing  to  lend  in  currency 
in  this  market;  if  his  opinion  is  the  other  way, then 
the  risk  will  have  to  be  assumed  by  the  borrower. 
He  will  receive  the  proceeds  of  the  bill  just  as  in 
the  other  case,  but  at  the  maturity  of  the  bill  he; 
must  provide  the  means  for  its  liquidation  in  Lon- 
don, paying  for  the  exchange  at  current  rates. 

209.  RELATION  OF  INTEREST  RATES 
TO  EXCHANGE  RATES.— It  will  thus  be  seen 
that  interest  rates  have  an  important  influence  upon 
fluctuations  in  exchange  rates  over  short  periods  of 
time.  Whenever  there  is  a  large  balance  of  pay- 
ments against  a  country,  temporary  borrowing  can 
not  prevent  exchange  rates  in  the  long  run  from 
moving  to  the  export  point.  But  within  limits  it  is 


238        LOANS   AND    INVESTMENTS 

possible  to  postpone  gold  movements  if  interest 
rates  go  to  a  much  higher  level  than  those  prevail- 
ing in  the  foreign  countries  to  which  heavy  pay-* 
ments  are  due.  In  such  circumstances,  so  long  as 
the  credit  of  the  debtor  market  remains  good  in 
foreign  countries,  very  considerable  temporary 
loans  may  be  made,  thus  providing  sight  exchange. 
But  if  a  large  number  of  three  month  bills  are 
drawn  now,  at  the  end  of  the  three  months'  period 
it  is  necessary  to  make  payments  or  secure  renewals 
and  renewals  can  not  be  continued  indefinitely. 

210.  UTILITY  OF  BANKERS'  TIME 
BILLS. — Within  moderate  limits,  borrowing  by 
means  of  bankers'  time  bills  serves  a  useful  purpose, 
tending  to  steady  the  sight  rate  of  exchange.  In 
the  absence  of  these  bills  a  comparatively  slight 
excess  in  the  demand  for  or  supply  of  exchange 
would  cause  rates  to  move  violently  between  the 
export  and  the  import  points.  When  drawn  for  the 
purpose  of  steadying  the  exchanges  they  are  some- 
times spoken  of  as  anticipatory  bills.  Bankers' 
bills,  for  example,  are  regularly  drawn  by  New 
York  in  the  early  summer  months,  because  it  is 
known  that  in  the  autumn  a  great  quantity  of  com- 
mercial exchange  will  come  into  the  market  in  con- 
nection with  exports  of  cotton  and  grain.  Antici- 
patory bills  are  in  no  sense  different  from  other 
bankers'  bills.  It  is  simply  that  within  limits  and 
at  certain  times  they  really  are  anticipatory.  The 
term  finance  bills  is  sometimes  used  in  a  derogatory 


LOANS   AND   INVESTMENTS        239 

sense,  as  if  commercial  bills  were  the  only  perfectly 
reputable  variety  of  bills  of  exchange.  Bankers' 
bills  are,  however,  essential  for  the  smooth  working 
of  the  exchanges.  Both  commercial  bills  and  bank- 
ers' are  serviceable  in  various  transactions. 

211.  BORROWING  AND  LENDING  EX- 
CHANGE MARKETS.— From  the  foregoing  dis- 
cussion it  may  have  been  inferred  that  there  are 
two  more  or  less  distinct  groups  of  foreign  ex- 
change markets — borrowing  markets  and  lending 
markets.  The  borrowing  markets  are  numerous, 
while  the  lending  markets  are  few,  with  a  strong 
tendency  for  a  single  market  to  acquire  nearly  the 
entire  business.  In  many  ways  it  is  advantageous 
to  have  one  city  in  the  world  which  serves  as  a 
centre  for  payments  between  all  parts  of  the  world. 
London  became  the  central  money  market  of  the 
world,  reaping  all  the  advantages  of  that  position, 
because  it  has  been  able  to  absorb  whatever  amount 
of  foreign  bills  might  be  sent  thither  for  discount. 
This  is  an  essential  condition  for  the  normal  work- 
ing of  the  exchanges  under  a  system  of  settlements 
largely  concentrated  in  a  single  market.  The  mar- 
ket on  which  bills  of  exchange  are  drawn,  as  we 
have  seen,  must  be  prepared  to  discount  them.  In 
order  to  avoid  the  risk  of  loss  from  fluctuations  in 
exchange,  bankers  purchasing  time  bills  drawn  on 
another  country,  must  be  able  to  discount  them 
at  once  in  that  market,  so  that  they  may  be  able 
to  sell  demand  exchange  against  the  proceeds. 


240        LOANS  AND   INVESTMENTS 

212.  ARRIVAL   RATES.— Exchange  bankers 
in  New  York  and  in  all  other  exchange  markets 
each  day,  and  oftener  if  rates  change,  receive  spot 
and  forward  delivery  quotations  from  London  cor- 
respondents.   Spot  quotations,  as  the  name  implies, 
are  discount  rates  on  bills  already  in  London.    For- 
ward delivery  quotations  are  the  rates  at  which 
London  bankers  and  discount  houses  agree  to  take 
bills  arriving  in  the  next  mail  from  the  market  to 
which  they  are  quoted.    These  arrival  rates  enable 
exchange  bankers  in  New  York  and  elsewhere  to 
purchase  time  bills  without  running  any  risk  from 
changes  in  London  discount  rates  while  the  bills 
are  in  transit.    When  downward  tendencies  in  Lon- 
don discount  rates  seem  probable,  the  banker  may 
not  take  advantage  of  the  arrival  rate;  just  as  in 
the  belief  that  exchange  rates  are  to  advance  he  may 
decide  to  hold  the  bills  to  maturity.    In  fact  the  ad- 
vantages and  uses  of  forward  delivery  quotations 
are  in  every  way  analagous  to  those  arising  from 
discounting  bills  which  have  already  been  delivered. 
In  one  case  the  arrangement  eliminates  risk  during 
the  transit  period,  in  the  other  during  the  entire  life 
of  the  bill  after  it  reaches  the  country  on  which  it 
is  drawn. 

213.  POSITION  OF  LONDON.— It  is  evident 
therefore  that  if  time  bills  of  exchange  are  to  be 
handled  with  a  minimum  of  risk  it  must  always  be 
possible  to  discount  them  in  the  country  on  which 
they  are  drawn.    This  has  always  been  possible  in 


LOANS   AND    INVESTMENTS        241 

London,  and  at  rates  which  have  averaged  some- 
what below  those  prevailing  in  other  money  mar- 
kets. For  this  reason  and  because  it  facilitates  set- 
tlements and  makes  possible  a  broad  exchange  mar- 
ket on  all  countries,  foreign  bills  of  exchange 
throughout  the  world  for  many  years  preceding 
the  European  War  had  been  principally  drawn  on 
London.  Persistent  efforts  to  give  bills  on  other 
money  centres,  notably  Berlin,  the  standing  of  the 
sterling  bill,  have  not  succeeded.  In  addition  to  its 
readiness  to  absorb  the  indefinitely  large  volume  of 
foreign  bills,  London  also  has  exercised  most  effec- 
tively another  essential  function— that  of  accepting 
bills  for  banks  and  traders  in  all  parts  of  the  world. 
Until  recently  the  acceptance  business  in  London 
was  conducted  almost  entirely  by  private  banking 
firms  known  as  accepting  houses;  but  of  late  years 
the  joint  stock  banks  have  entered  this  field.  The 
value  of  the  London  acceptance  was  due  not  so 
much  to  the  financial  strength  of  the  acceptors  as 
to  the  knowledge  of  the  financial  standing  of  banks 
and  traders  throughout  the  world  which  they  had 
acquired,  and  the  skill  and  restraint  which  they  had 
manifested  in  the  conduct  of  this  important  branch 
of  the  banking  business. 

214.  EUROPEAN  WAR  AND  THE  EX- 
CHANGES.—These  various  interdependent  for- 
eign exchange  functions  have  been  developed  dur- 
ing a  long  period  in  which  peace  had  become  the 
normal  condition  of  the  world.  It  is,  therefore,  no 


242        LOANS    AND    INVESTMENTS 

more  than  was  to  have  been  expected  that  with  the 
approach  of  the  European  war  the  entire  mechan- 
ism of  foreign  exchanges  should  be  so  seriously 
dislocated  as  to  come  almost  to  a  standstill.  Onj 
Saturday,  July  25th,  1914,  foreign  exchange  opera- 
tions were  still  being  conducted  in  normal  fashion 
throughout  the  world.  Demand  exchange  in  New 
York  was  quoted  at  $4.8830.  Gold  exports  in  con- 
siderable quantities  seemed  imminent,  but  nothing 
more  serious  seems  to  have  been  expected.  Over 
Sunday  the  outbreak  of  a  general  European  War, 
which  had  been  commonly  regarded  as  a  vague  pos- 
sibility, became  alarmingly  probable.  On  Monday 
demand  exchange  opened  at  $4.92  and  the  foreign 
exchange  market  was  completely  disorganized. 
This  condition  was  in  no  way  peculiar  to  New  York. 
Foreign  exchange  dealings  between  all  of  the 
money  markets  of  the  world  were  in  a  similar  ab- 
normal state.  In  no  other  business  was  the  effect 
of  the  approach  of  the  war  felt  so  immediately, 
generally  and  severely.  The  complicated  and  deli- 
cately balanced  mechanism  of  foreign  exchanges, 
developed  during  long  years  of  peaceful  intercourse, 
collapsed  like  a  house  of  cards. 

215.  THE  WAR  AND  THE  LONDON  AC- 
CEPTANCE.—Two  operations  essential  for  the 
working  of  the  foreign  exchanges  had  been  instantly 
interrupted,  and,  indeed,  practically  discontinued — 
the  business  of  accepting  and  that  of  discounting 
foreign  bills  of  exchange  in  London.  When  Lon- 


LOANS   AND    INVESTMENTS        243 

don  ceased  to  perform  these  two  functions,  the 
mechanism  of  the  foreign  exchanges  throughout 
the  world  inevitably  and  at  once  became  completely 
disorganized.  Acceptors  on  London  were  under 
heavy  obligations  on  bills  of  exchange  drawn  by 
banks  and  merchants  throughout  the  world,  who 
in  turn  were  under  obligation  to  remit  funds  to 
them  before  the  maturity  of  the  bills.  Among  these 
bills  accepted  in  the  ordinary  course  of  business 
were  a  large  number,  amounting  in  the  aggregate 
doubtless  to  many  millions  of  pounds,  for  banks  and 
merchants  in  the  countries  which  were  rapidly  drift- 
ing toward  war.  Remittances  could  not  be  expected 
from  parties  in  hostile  countries  until  after  the  res- 
toration of  peace.  It  was  also  certain  that  remit- 
tances would  be  delayed  in  many  instances  in  the 
case  of  bills  accepted  for  clients  in  allied  and  also 
in  neutral  countries,  owing  to  the  disturbances  oc- 
casioned by  the  outbreak  of  the  war.  In  these  cir- 
cumstances acceptors  in  London  were  in  no  position 
to  make  new  acceptances,  and  the  value  of  the  ac- 
ceptance itself  was  impaired.  It  should  further  be 
noted  that  exchange  banks  in  New  York  and  in  all 
other  markets  were  under  heavy  contingent  liabili- 
ties on  account  of  endorsements  of  bills  drawn  on 
London  acceptors.  In  the  event  of  the  failure  of 
London  accepting  houses,  these  bankers  would  have 
to  supply  funds  to  take  up  the  bills,  and  in  the  dis- 
turbed conditions  prevailing  might  incur  serious 
loss  through  the  failure  of  drawers,  to  whom  of 


244        LOANS   AND   INVESTMENTS 

course  they  would  have  recourse.  Uncertainty  re- 
garding the  value  of  the  London  acceptance  com- 
pletely transformed  the  character  of  the  business 
of  buying  commercial  bills  of  exchange.  A  busi- 
ness which  normally  is  highly  secure  and  even  rou- 
tine in  character  was  in  a  moment  changed  to  one 
surrounded  with  uncertainties  of  a  most  unfamiliar 
and  incalculable  nature.  At  the  same  time  shipping 
hazards,  and  uncertainty  as  to  market  conditions 
in  foreign  countries,  were  taking  away  much  of  the 
value  of  the  security  which  the  bill  of  lading  ordi- 
narily gives  in  the  case  of  bills  drawn  against  ex- 
ports. Both  exporters  and  those  who  might  pur- 
chase their  bills  would  therefore  be  embarking  upon 
venturesome  transactions,  utterly  lacking  the 
highly  developed  safeguards  which  normally  pro- 
tect international  dealings,  both  in  commodities 
and  in  bills  of  exchange. 

216.  THE  WAR  AND  THE  LONDON  DIS- 
COUNT MARKET.— The  consequences  of  the  un- 
certain position  in  which  London  acceptors  were 
placed  by  the  approach  of  the  war  do  not  seem  to 
have  been  at  once  fully  realized  even  in  foreign  ex- 
change circles.  They  were  perhaps  overshadowed 
by  the  presence  of  another  disorganizing  influence, 
the  full  force  of  which  was  immediate  and  obvious. 
From  Monday,  July  27,  to  the  middle  of  August, 
the  business  of  discounting  foreign  bills  in  London 
was  almost  entirely  suspended.  With  the  approach 
of  the  war  it  might  well  have  been  presumed  that 


LOANS   AND    INVESTMENTS        245 

London  would  decline  to  quote  forward  delivery 
rates  before  the  discounting  of  bills  already  in  Lon- 
don was  discontinued.  As  it  happened,  both  spot 
and  forward  delivery  quotations  were  discontinued 
at  the  same  time,  on  Monday,  July  27,  striking  evi- 
dence of  the  great  change  for  the  worse  which  af- 
fairs had  taken  over  Sunday. 

217.  THE  WAR  AND  THE  NEW  YORK 
EXCHANGE  MARKET.— This  discontinuance  of 
discount  quotations  by  London  was  the  most  im- 
portant single  factor  in  the  exchange  market  in 
New  York  and  elsewhere  throughout  the  world  on 
Monday,  July  27.  It  involved  a  complete  transfor- 
mation, not  only  of  the  business  of  buying  commer- 
cial bills,  but  also  of  conditions  in  the  demand  ex- 
change market  as  well.  On  Saturday  the  exchange 
banker  purchasing  commercial  bills  could  arrange 
discount  terms  at  once  in  London  and  sell  demand 
exchange  against  the  proceeds.  On  Monday  the 
purchase  of  such  bills  involved  the  investment  of 
capital  until  the  date  of  maturity  in  a  far  from  satis- 
factory security,  owing  to  the  position  of  London 
acceptors.  On  Saturday  every  commercial  bill  of- 
fered in  the  market  provided  the  means  for  an  im- 
mediate sale  of  demand  exchange.  On  Monday  the 
immediate  supply  of  demand  exchange  could  no 
longer  be  enlarged  to  the  slightest  extent  by  this 
means.  The  principal  source  of  an  immediate  sup- 
ply of  a  demand  exchange  was  entirely  cut  off. 
Demand  exchange  could  still  be  sold  against  for- 


246        LOANS   AND    INVESTMENTS 

eign  balances,  but  these  were  not  large.  The  ex- 
portation of  gold  was  a  further  source  of  supply  of 
demand  exchange,  but  could  not  go  on  indefinitely 
without  endangering  the  foundation  of  the  domes- 
tic credit  structure.  In  these  circumstances,  al- 
though exchange  transactions  were  not  entirely 
suspended,  there  was  a  complete  cessation  of  cer- 
tain exchange  operations,  in  the  absence  of  which 
there  can  be  no  broad  exchange  market.  Each 
dealer  made  every  effort  to  provide  the  exchange 
urgently  needed  by  regular  customers,  but  trans- 
actions between  dealers  were  almost  altogether  dis- 
continued. In  normal  times,  by  offering  to  buy 
exchange  at  higher  prices,  a  dealer  can  secure  what- 
ever amount  he  may  require.  At  such  times  changes 
in  rates  serve  to  adjust  supply  and  demand  in  the 
exchange  market.  Beginning  with  Monday,  July 
27,  rates  merely  reflected  the  urgent  and  even  fran- 
tic efforts  of  particular  purchasers  to  secure  ex- 
change. Rates  fluctuated  widely,  but  as  each  trans- 
action stood  by  itself  they  had  no  general  market 
significance. 

218.  THE  WAR  AND  THE  LONDON 
SIGHT  RATE.— Through  the  assistance  of  the 
British  Government,  London  was  able  to  resume, 
toward  the  end  of  August,  1914,  both  the  accepting 
and  discounting  of  bills.  But  a  few  months  later  a 
new  cause  of  difficulty  presented  itself.  Sterling 
exchange,  which  throughout  the  world  had  ruled 
far  above  par  for  some  time  after  the  outbreak  of 


LOANS   AND    INVESTMENTS        247 

the  war,  gradually  began  to  decline,  at  first  slowly, 
then  more  rapidly,  until  it  was  far  below  the  gold 
export  point  from  London.  By  August,  1915,  ster- 
ling exchange  in  New  York  had  dropped  to  $4.50, 
and  fluctuated  widely  over  short  periods  of  time. 
In  other  words,  the  base  rate  from  which  rates  on 
all  time  bills  are  calculated  no  longer  fluctuated 
within  narrow  and  definite  limits  between  the  ex- 
port and  import  points.  It  consequently  became  an 
unsatisfactory  medium  in  which  to  enter  into  con- 
tracts for  payment  at  a  future  date.  This  unsatis- 
factory position  of  the  sterling  rate  was  due  to  the 
enormous  importations  of  supplies  to  Great  Britain 
on  account  of  the  war.  Toward  the  end  of  1915  ar- 
rangements were  finally  made  for  financing  these 
purchases  largely  through  the  negotiation  of  loans 
in  the  United  States;  and  thereafter  the  sterling 
rate  was  pegged  at  about  $4.76.  The  establish- 
ment of  a  stationary  base  in  this  artificial  manner 
could  not,  however,  give  that  confidence  in  sterling 
which  it  enjoyed  when  subject  only  to  slight 
changes  due  to  normal  trade  and  credit  influences. 
219.  DEVELOPMENT  OF  DOLLAR  EX- 
CHANGE.—The  European  war,  it  will  thus  be 
seen,  created  conditions  favorable  to  the  develop- 
ment of  the  business  of  drawing  bills  of  exchange 
on  other  markets  than  London,  and  in  particular  on 
New  York,  the  most  important  financial  centre  in 
neutral  countries.  Fortunately  the  power  to  accept 
bills  of  exchange,  had  been  granted  to  the  national 


248        LOANS   AND   INVESTMENTS 

banks  by  the  Federal  Reserve  Act  of  1913,  and  also 
to  State  banks  and  trust  companies  in  a  number  of  the 
States,  Moreover,  after  the  disturbance  occasioned 
by  the  outbreak  of  the  war  had  been  overcome,  dis- 
count rates  in  New  York  fell  to  a  level  distinctly 
below  that  in  London.  Under  these  favorable  cir- 
cumstances American  bankers  entered  the  foreign 
exchange  field  as  acceptors  and  lenders.  Commer- 
cial letters  of  credit  providing  for  the  acceptance  of 
bills  payable  in  dollars  have  proved  satisfactory 
both  to  American  and  foreign  traders.  As  a  factor 
in  creating  the  existing  demand  for  Dollar  Credits, 
the  establishment  of  American  branch  banks  abroad 
cannot  be  emphasized  too  strongly.  Through  these 
branch  banks,  a  new  and  adequate  medium  for  the 
liquidation  of  transactions  as  between  the  United 
States  and  certain  foreign  countries  has  been  placed 
at  the  disposal  of  American  merchants.  A  direct 
channel  is  now  open  to  the  ebb  and  flow  of  credit 
transfer  between  the  United  States  and  the  coun- 
tries mentioned,  and,  as  a  natural  sequence,  the 
former  disparity  existing  against  the  Dollar,  as 
compared  with  Pound  Sterling  and  the  principal 
Continental  exchanges,  has  disappeared.  The  re- 
sulting equalization  in  the  rates  of  exchange 
benefits  the  American  merchant  to  the  extent  of 
relieving  him  of  the  charges  formerly  paid  to  the 
indirect  channels  of  liquidation,  or,  in  other  words, 
to  the  foreign  banker.  The  Dollar  Credit  is  of 
capital  importance  to  every  American  merchant 


LOANS   AND   INVESTMENTS        249 

who  is  interested  either  directly  or  indirectly  in 
the  importation  of  commodities  of  any  character. 
A  study  of  the  advantages  accruing  from  this  form 
of  credit  will  demonstrate  the  desirability  of  its 
general  employment  as  the  vehicle  for  financing 
not  only  our  own  imports  but  also  those  of  other 
countries.  Primarily,  it  is  more  economical  than 
the  Sterling  or  Continental  Credit,  for  the  initial 
commission  cost  of  issuance  is  lower.  Secondly, 
it  is  based  on  a  known  quantity,  the  Dollar,  a  fac- 
tor of  supreme  importance  in  these  days  of  extreme 
and  violent  fluctuations  in  the  exchange  rates,  and 
therefore  all  exchange  risk  is  eliminated  from  the 
operation  as  far  as  the  importer  is  concerned. 
Maturities  drawn  under  Dollar  Credits  are  due  and 
payable  in  Dollars  on  a  given  date,  and  no  question 
arises  as  to  what  the  exchange  rate  on  London 
may  be  90  days  after  acceptance  of  the  bill. 

220.  FOREIGN  EXCHANGE  AFTER  THE 
WAR. — It  is  advantageous,  both  to  importers  and 
exporters,  to  have  bills  drawn  on  a  single  central 
world  market,  rather  than  on  cities  in  each  of  the 
countries  with  which  they  are  trading.  There  has 
been  a  broad  market  everywhere  for  sterling  bills, 
because  not  only  trade  with  England  but  with  all 
countries  has  been  handled  by  means  of  bills  drawn 
on  London.  If  a  prolonged  period  of  peace  is  to 
be  anticipated  at  the  close  of  the  present  war,  the 
supremacy  of  London  foreign  exchange  market  will 
probably  continue.  On  the  other  hand  if  national 


250        LOANS   AND   INVESTMENTS 

enmities  are  to  be  continued  and  strife  is  merely 
transferred  from  the  battle  field  to  the  market  place, 
the  convenience  of  a  central  money  market  will  pre- 
sumably not  be  sufficient  to  warrant  the  risk  in  the 
event  of  further  outbreaks.  Moreover,  if  interna- 
tional trade  is  to  be  developed  by  national  organiza- 
tions, primarily  for  national  objects,  rather  than  for 
individual  profit,  it  will  be  necessary  for  each  im- 
portant country  to  organize  the  financial  machinery 
needed  for  handling  its  own  trade. 

221.  NATIONAL  FOREIGN  TRADE  POL- 
ICY.— Foreign  trade  is  to  be  an  ever  increasingly 
important  factor  in  the  future  development  of 
America.  The  banker's  interest  in  this  develop- 
ment is  vital  not  only  to  himself,  but  to  the  citizen- 
ship of  his  country.  The  close  relationship  of 
banking  and  foreign  trade  and  national  welfare  is 
clearly  set  forth  by  F.  A.  Vanderlip,  President  of 
the  National  City  Bank  of  New  York,  in  the  follow- 
ing words: 

(1)  "There  is  a  disposition  sometimes  to  compare  do- 
mestic trade  with  our  foreign  business  and  to  say  that,  after 
all,  foreign  trade  is  a  small  matter,  and  we  have  field  enough 
at  home.  I  want  to  try  to  show  the  dangerous  narrowness 
of  that  view  by  drawing  some  illustrations  from  the  bank- 
ing situation.  A  bank's  reserve  is  the  cash  which  the  banker 
has  in  his  vault.  That,  in  the  main,  must  be  gold,  and  is,  in 
fact,  all  gold,  or  its  representative,  the  gold  certificate,  ex- 
cept a  moderate  amount  of  United  States  notes  and  silver. 
The  foundation  of  all  banking  credit  is  the  gold  reserve. 
The  structure  of  banking  credit  must  stand  on  that  founda- 


LOANS   AND    INVESTMENTS        251 

tion,  and  its  size  is  directly  governed  by  the  amount  of  re- 
serve the  banks  hold. 

(2)  "I  could  visually  illustrate  the  relation,  which  you 
all  already  understand,  if  I  had  a  flat  disc  of  gold  and  some 
sand.    I  could  pile  sand  on  that  flat  disc  of  gold  to  a  perfectly 
definite  amount,  governed  by  two  factors,  the  size  of  the  disc 
and  the  angle  at  which  the  sand  would  lie  undisturbed. 
Suppose  we  let  that  angle  be  the  measure  of  our  legal  re- 
serve requirement.    In  the  passage  of  the  Federal  Reserve 
Act  that  angle  was  increased  when  we  lowered  the  ratio  of 
reserve  that  banks  must  hold.    We  are  now  able  to  base  a 
taller  structure  of  banking  credit  upon  a  given  gold  basis, 
and  to  do  so  safely,  than  we  were  before  the  Federal  Re- 
serve banks  were  created. 

(3)  "Now,  the  tendency  in  every  bank  management  is 
to  loan  money  so  long  as  sound  borrowers  can  be  found  and 
the  bank  has  in  its  vault  idle  funds  above  its  legal  reserve 
requirements.    That  is  to  say,  on  our  gold  disc  will  be  piled 
all  the  grains  of  sand,  letting  them  represent  loans,  that  can 
be  placed  there.    If  our  gold  disc  is  enlarged,  the  amount  of 
sand  we  can  pile  on  it  is  increased  eight  or  ten  times  as  much 
as  the  amount  of  fresh  gold  added  to  the  gold  base,  for  the 
structure  of  bank  credit  normally  bears  a  relation,  taking 
the  country  as  a  whole,  of  eight  or  ten  times  the  size  of  the 
gold  reserve.     Now,  conversely,  if  through  any  banking 
operation  the  gold  reserve  is  reduced  the  same  thing  will 
happen  to  the  structure  of  bank  credit  as  must  happen  to  my 
pile  of  sand  if  I  decrease  the  diameter  of  my  gold  disc. 
Credits    must   be   reduced    approximately    ten   times    the 
amount  that  the  gold  base  is  reduced.    It  was  a  recognition 
of  this  principle  and  an  appreciation  of  the  havoc  which  it 
plays  when  reserves  are  rudely  disturbed  which  led  to  de- 
vising the  Federal  Reserve  Law  and  the  mobilization  of  all 
reserves,  so  that  we  cannot  again  have  just  the  sort  of  dis- 
turbance, and  even  panics,  that  used  to  follow  the  normal 


252        LOANS   AND    INVESTMENTS 

seasonal  shipment  of  reserve  money  out  of  the  financial 
centers  for  crop  moving  operations.  We  have  safeguarded 
that  danger,  but  we  have  not  altered  the  principle,  and  if 
the  country  faces  a  situation  where,  through  any  other 
process,  the  gold  reserve  may  at  one  time  be  greatly  aug- 
mented and  the  credit  structure  built  full-sized  upon  it,  and 
then  through  the  operation  of  trade  balances,  if  gold  is  drawn 
out  from  under  that  credit  structure,  the  credits  must  be 
reduced  in  corresponding  ratio  as  surely  as  the  pile  of  sand 
upon  the  gold  disc  would  decrease  if  we  began  to  clip  from 
the  edge  of  the  disc  the  foundation  upon  which  the  sand 
stood. 

(4)  "So  much  for 'the  illustration!    Now,  what  is  it  that 
we  have  seen  happen  since  the  outbreak  of  the  war  in  our 
domestic  banking  situation?    There  have  been  two  factors 
that  worked  toward  an  increased  credit  structure.     The 
Federal  Reserve  Law,  reducing  reserve  requirements,  went 
into  effect,  that  is  to  say,  the  angle  at  which  the  sand  lay  on 
the  gold  disc  was  increased,  and  we  have  had  an  enormous 
influx  of  gold ;  in  other  words  the  gold  disc  was  greatly  en- 
larged.   The  result  was  easy  to  foresee.    Bankers  always 
loan  an  idle  surplus  if  they  can,  and  it  is  not  surprising  then, 
if  we  turn  to  statistics,  to  see  that  the  loans  and  discounts  of 
National  banks  alone  have  gone  up  more  than  a  billion 
dollars  and  for  all  the  banks  the  total  would  not  fall  far 
short  of  two  billion  dollars.    Our  heap  of  sand  on  the  gold 
disc  is  about  one-sixth  larger  than  it  was  when  the  war 
broke  out. 

(5)  "What  is  going  to  happen  to  that  gold  disc  when 
the  war  is  over?    What  defense  have  we  for  our  gold  re- 
serve?   What  program  of  preparedness  are  we  working  out 
to  meet  the  international  attack  that  is  threatened  to  be 
made  upon  the  gold  foundation  of  our  credit  system?    Do 
you  recognize  why  that  question  is  of  vital  interest  to  every 
citizen,  to  every  man  with  a  bank  account?    The  interior 


LOANS   AND   INVESTMENTS        253 

farmer,  merchant  or  manufacturer,  wholly  local  in  his  inter- 
ests, may  think  he  has  but  the  remotest  interest  in  foreign 
trade;  he  is,  however,  interested  in  bank  reserves,  and  the 
course  of  foreign  trade  as  it  reacts  on  those  reserves  will 
affect  his  business  future  to  an  extent  that  may  some  day 
amaze  him. 

(6)  "So  long  as  the  war  goes  on  the  world  will  be  so 
tipped  askew,  in  all  probability,  that  the  gold  holdings  of 
other  countries  will  continue  to  fall  into  our  lap     As  the 
gold  falls  it  will  be  added  to  our  reserves.    As  those  reserves 
grow,  so  will  grow  our  credit  structure  based  upon  them. 
When  the  war  is  ended,  we  will  find  all  Europe  depleted  of 
its  gold,  staggering  under  a  weight  of  inflated  bank  and 
government  paper,  and  under  the  direst  stress  to  rebuild 
its  stock  of  gold.    The  point  of  attack  will  be  our  gold  re- 
serves.   The  methods  will  be  every  means  known  to  trade 
and  commerce  by  which  merchandise,  securities  and  credits 
can  be  exchanged  for  gold.    The  laws  of  political  economy 
will  be  on  the  side  of  the  attack.    A  plethora  of  gold,  such  as 
we  will  have  always  means  rising  prices.    We  will  establish 
a  price  basis  here  which  will  make  us  a  good  market  to  sell 
in  and  a  bad  market  to  buy  in.    We  are  now  advancing  our 
labor  costs,  and  that  and  every  other  element  that  enters 
into  production  will,  under  the  influence  of  this  giyat  in- 
crease in  our  gold  reserves,  tend  toward  high  market  values. 

(7)  "If  we  find  ourselves,  when  conditions  start  again 
toward  the  normal,  to  be  the  market  where  prices  are  the 
highest,  where  the  cost  of  production  is  the  greatest,  and 
where  the  interest  rate  is  the  lowest,  the  road  will  be  open 
for  attack  upon  our  gold  reserves.    If  that  attack  is  suc- 
cessful, then  the  whole  credit  structure  that  will  have  been 
reared  upon  it  must  be  rudely  reduced,  for  the  reduction  in 
credits  must  be  manyfold  greater  than  the  loss  of  gold.  What 
defense  can  we  put  up?    How  can  we  safeguard  ourselves? 
We  have  recognized  the  principle  and  safeguarded  ourselves 


254        LOANS   AND   INVESTMENTS 

in  a  domestic  way  by  the  enaction  of  the  Federal  Reserve 
Law,  but  there  can  be  no  safeguarding  by  law  from  an  inter- 
national attack  upon  our  gold  stock.  Other  means  must  be 
found  than  any  that  could  be  provided  by  legislation.  Nor, 
do  the  means  lie  in  the  hands  of  the  bankers.  They  may  rec- 
ognize the  danger,  and,  instead  of  loaning  to  the  limit  per- 
mitted by  law,  run  with  strong  reserves;  but  any  surplus 
that  we  could  expect  the  bankers  to  hold  would  suffice  for 
but  a  short  time  if  the  drain  were  severe.  We  may  invest 
in  short  term  foreign  loans  that  can  be  converted  into  credits 
to  check  a  gold  demand.  We  have  already  done  some  of 
that  and  will  probably  do  a  good  deal  more.  There  have 
been  bankers  so  short-sighted  as  to  object  to  our  making  any 
loans  abroad,  but  I  believe  the  day  will  come  when  you  will 
find  that  those  loans,  convertible  into  credits, — as  they  will 
be, — will  form  a  check  to  gold  withdrawals,  and  be  one  of 
the  most  important  safeguards  of  our  gold  stock.  But  efforts 
in  the  way  of  defense,  such  as  excessive  reserves  or  short 
term  foreign  investments,  must  be  as  nothing  when  com- 
pared to  what  is  possible  in  the  form  of  credits  created  by 
exports  of  produce  and  merchandise.  There  is  the  strength 
of  our  defense.  Its  effective  measure  will  be  the  size  of  our 
exports  compared  to  our  imports.  The  size  of  that  favorable 
balance  must  form  the  true  defense  of  our  gold  stock.  That 
is  why  every  citizen,  whether  he  knows  it  or  not,  is  inter- 
ested in  the  subject  of  National  trade  policy." 


CHAPTER  VII 

Bonds  and  Circulating  Notes 

222.  BANK  NOTES  AND  DEPOSITS.— 
There  has  been  a  general  failure  in  popular  discus- 
sion of  banking  to  recognize  the  identity  of  the  note 
and  the  deposit  so  far  as  they  relate  to  the  bank 
itself.  There  may  be  a  difference  of  opinion  about 
the  comparative  effects  of  notes  and  deposits  upon 
the  level  of  prices  and  the  general  business  of  the 
community,  but  none  about  their  relationship  to 
the  bank.  If  the  borrower  presents  himself  at  a 
bank  for  accommodation,  has  his  security  accepted, 
and  his  loan  granted,  there  is  no  theoretical  differ- 
ence so  far  as  the  bank  is  concerned  whether  it 
credits  him  with  $1,000  on  its  books  and  allows 
him  to  draw  it  out  at  pleasure,  or  to  transfer  it 
to  others,  or  whether  it  hands  him  a  package  of 
one  thousand  one  dollar  demand  notes,  which  he 
may  present  at  sight  for  payment,  or  which  he  may 
hand  to  one  thousand  other  persons,  who  may  pre- 
sent them  if  they  choose.  Whether  the  bank  has 
credited  the  borrower  with  $1,000,  or  has  given 
him  one  thousand  one  dollar  demand  notes  (or 
"bank  notes"),  it  is  in  exactly  the  same  position 
so  far  as  the  outside  world  is  concerned — that  is  to 
say,  it  has  accepted  the  borrower's  note  for  $1,000 
and  in  return  has  given  him  a  sight  claim  for  $1,000 
upon  itself,  the  consideration  being  a  rate  of  interest 

255 


256        LOANS   AND    INVESTMENTS 

of  specified  amount.  The  bank  note  must,  there- 
fore, be  looked  upon  from  the  standpoint  of  bank- 
ing just  as  is  the  bank  deposit — as  a  sight  liability. 
223.  RELATION  OF  NOTES  TO  CUR- 
RENCY.— The  note,  when  once  issued,  differs 
from  the  deposit  in  its  practical  effect  upon  the 
bank  only  in  respect  to  the  time  it  remains  in  cir- 
culation. It  is  plain  that  $1,000  in  notes  paid  out 
by  a  bank  over  its  counter  may  be  almost  immedi- 
ately placed  on  deposit  with  it,  in  which  case  all 
that  has  happened  has  been  that  the  bank  has  ex- 
changed one  form  of  liability  for  another  form. 
But  such  an  issue  of  notes  may  remain  in  the  hands 
of  individuals  for  a  great  while.  If  there  is  absolute 
confidence  on  the  part  of  such  individuals  that  the 
bank  is  solvent  and  able  to  pay  its  obligations,  and 
if  there  is  a  shortage  of  currency  in  the  community 
so  that  the  bank  notes  fill  a  convenient  place,  the 
life  of  the  notes  may  be  very  long.  In  case  of  the 
deposit,  the  existence  of  the  credit  upon  which  that 
deposit  is  based  may  be  equally  long.  Thus,  if  a 
single  bank  does  the  business  of  a  given  community, 
and  grants  a  credit  of  $1,000  to  a  borrower,  who 
secures  a  renewal  of  his  credit  from  time  to  time, 
it  is  possible  that  this  credit  may  be  indefinitely 
continued,  while  the  claim  on  the  bank  may  be 
passed  from  hand  to  hand  in  the  form  of  checks. 
As  a  matter  of  fact,  a  check  does  not  pass  many 
times  before  it  is  presented  for  redemption,  while 
the  practice  of  commercial  banks  is  not  to  grant  too 


LOANS   AND   INVESTMENTS        257 

frequent  or  too  long  renewals  of  credits.  This 
means  that  any  given  draft  upon  a  deposit  is  not 
likely  to  remain  long  in  existence,  while  the  credit 
which  brought  it  into  existence  is  itself  likely  to 
be  terminated  at  a  comparatively  early  day. 

224.  BANK  NOTES  AND  CHECKS.— The 
same  thing  is  true  of  the  loan  on  the  strength  of 
which  bank  notes  are  issued,  but  the  bank  note 
itself*  may  pass  from  hand  to  hand  a  great  many 
more  times  than  would  a  check  for  an  equal  amount. 
In  other  words,  the  circulation  activity  of  the  bank 
note  is  likely  to  be  much  greater  than  that  of  the 
deposit  of  equal  face  value.  This  means  that  the 
bank  note  has  a  somewhat  different  status  as  cur- 
rency from  that  which  is  occupied  by  the  deposit 
subject  to  check.  How  far  the  currency  activity 
of  the  note  affects  prices  in  a  way  different  from 
the  influence  exerted  by  the  deposit  need  not  be 
discussed  at  this  point,  it  being  a  problem  of  money 
rather  than  of  banking.  The  fact  remains  that  the 
bank  note  performs  a  "currency  function"  which 
has  generally  been  considered  more  important  than 
that  of  the  deposit.  If  a  given  volume  of  bank 
notes  is,  on  the  average,  maintained  in  circulation 
in  any  given  country,  such  volume  evidently  dis- 
places an  equal  amount  of  some  other  form  or 
forms  of  currency  or  coin.  This  may  be  a  desirable 
feature  of  the  bank  note  system,  inasmuch  as  it 
substitutes  a  credit  instrument  of  comparatively 
low  cost  for  a  costly  circulating  medium  like  gold. 


258        LOANS   AND    INVESTMENTS 

225.  PROTECTION  OF  NOTES.— Because 
of  this  "currency  function,"  it  has  been  felt  by 
legislators  in  most  countries  that  the  issue  of  bank 
notes  ought  to  be  controlled  with  great  care,  and 
as  a  result  numerous  methods  for  restricting  note 
issues  have  been  attempted.  This  protection  may 
take,  and  does  in  practice  take,  several  different 
forms.  One  of  the  most  familiar  forms  is  the 
limiting  of  the  total  amount  of  bank  notes  to  be 
issued  by  a  given  institution.  A  second  mode  of 
protecting  the  note-holder  is  that  of  setting  aside 
a  special  security  for  the  protection  of  notes.  Thus 
banks  may  be  directed  to  invest  in  a  given  kind 
of  bonds  a  sum  equal  to  the  amount  of  the  notes 
they  issue.  This  type  of  control  is  seen  in  the 
National  banking  system.  Coupled  with  this  (as 
seen  in  the  National  banking  system)  may  be  a 
provision  that  the  notes  shall  be  a  first  lien  upon 
the  assets  of  the  bank  which  issues  them.  A  third 
method  of  protecting  a  note  issue  may  be  the  flat 
guarantee  of  the  government  which  has  chartered 
the  issuing  bank  that  in  the  event  of  the  failure  of 
such  bank  it  will  assume  a  responsibility  for  its 
notes.  A  fourth  mode  of  protection  may  be  found 
in  regulations  designed  to  control  the  classes  of 
security  which  shall  be  held  by  banks  behind  their 
notes.  Thus  banks  may  be  directed  not  to  issue 
more  notes  than  are  protected  by  given  classes  of 
commercial  security.  This  has  the  effect  of  limit- 
ing note  issues  beyond  a  certain  point  to  those 


LOANS   AND   INVESTMENTS        259 

classes  of  loans  in  which  the  specified  kind  of 
security  can  be  obtained.  A  fifth  mode  of  protec- 
tion is  seen  in  the  establishment  of  peculiar 
facilities  for  redemption  of  notes  and  for  assuring 
their  prompt  return  to  the  bank  which  put  them  out. 

226.  WHY     NOTES    ARE    ISSUED.— The 
issue  of  bank  notes  is  taken  as  so  much  a  matter 
of  course  that  the  reason  for  their  issue  is  not 
usually  considered  in  much  detail.    In  fundamental 
analysis,  of  course,  the  notes  come  out  for  exactly 
the  same  reasons  which  govern  the  creation  of 
deposits — someone  secures  a  loan  from  the  bank, 
and  the  credit  corresponding  thereto  is  granted  in 
the  form  of  a  note  issue.    But  this  does  not  explain 
the  selection  of  the  note  as  compared  with  the 
deposit.    There  must  be  some  reason  determining 
whether  a  note  will  be  handed  to  a  borrower  or 
whether  a  credit  of  like  amount  will  be  written  in 
a  pass  book.    This  is  usually  a  question  of  business 
convenience  merely,  and  as  such  is  to  be  settled  by 
the  borrower  (always  supposing  that  the  bank  is 
able  to  issue  the  note  if  it  chooses,  under  the  exist- 
ing law).    The  borrower  may  prefer  notes  because 
of  their  greater  acceptability  to  the  person  or  per- 
sons to  whom  they  are  to  be  paid. 

227.  THEORY    OF  NOTE    ISSUE.— From 
what  has  been  said  it  is  clear  that  the  theory  of 
note  issues  in  their  relation  to  the  bank  is  identical 
with  that  of  deposits  and  their  relation  to  the  bank. 
There  is  in  fact  no  distinction  to  be  drawn  in  this 


260        LOANS   AND    INVESTMENTS 

respect  between  the  note  and  the  deposit.  The 
putting  out  of  an  issue  of  notes  will  be  considered 
by  the  bank  under  exactly  the  same  terms  and  con- 
ditions as  those  which  have  controlled  it  in  regard 
to  the  creation  or  grant  of  a  line  of  credit  based 
on  deposits.  The  classes  of  security  accepted  by 
the  bank  when  it  is  asked  to  make  an  issue  of  notes 
are  the  same  as  those  which  it  will  accept  when 
granting  a  loan  in  the  form  of  a  credit  on  its  books. 
The  protection  of  the  bank  against  loss  depends 
entirely  upon  the  security  which  it  receives,  and 
the  standing  of  the  borrower  who  gets  the  loan. 
There  is  no  special  profit  in  the  issue  of  notes  that 
does  not  inhere  in  the  creation  of  deposits. 

228.  SECURITY  FOR  BANK  NOTES.— The 
question  whether  note  issues  should  be  given  any 
ultimate  security  different  from  that  possessed  by 
the  other  liabilities  of  the  bank  has  been  consid- 
erably discussed  and  opinions  vary  widely  with 
reference  to  it.  Probably  the  best  opinion  of  the 
day  is  that  no  such  special  security  is  desirable, 
but  that  the  safety  of  the  note-holder  is  to  be  pro- 
vided for  by  means  of  prompt  and  active  redemp- 
tion and  by  confining  the  issue  of  notes  to  banks 
whose  capital  is  large  enough  and  whose  methods 
are  sound  enough  to  assure  the  note-holder  and 
the  government  that  there  will  be  a  high  degree 
of  responsibility  on  the  part  of  the  institution.  This 
idea  is  carried  a  step  further  when  provision  is 
made  (as  in  the  Canadian  banking  system)  for 


LOANS   AND    INVESTMENTS        261 

making  the  banks  jointly  liable  for  the  notes  of 
all  insolvent  banks.  In  the  case  of  the  Canadian 
banks,  the  result  is  accomplished  by  compelling 
banks  which  desire  to  issue  notes  to  put  up  a  jointly 
contributed  fund  called  a  "guaranty  fund"  on  which 
the  notes  of  any  insolvent  bank  may,  under  certain 
circumstances,  be  made  to  draw.  The  result  of 
such  a  provision  is  to  make  banks  exercise  an  over- 
sight over  one  another's  issues  and  to  create  a 
probably  higher  degree  of  watchfulness  than  would 
exist  were  the  banks  severally,  but  not  jointly, 
liable  for  the  outstanding  notes. 

229.  BONDS  AND  BANK  NOTES.— Such  a 
system,  however,  is  entirely  different  from  one  in 
which  a  bank  is  compelled,  before  issuing  any  notes, 
to  lay  aside  a  part  of  its  assets  in  a  segregated  fund 
for  the  purpose  of  protecting  the  note  issue  based 
thereon.  This  is  the  system  employed  under  the 
National  Bank  Act  of  the  present  day  and  has 
proved  to  be  unsatisfactory.  Every  National  bank 
upon  being  organized  was  originally  required  to 
buy  an  amount  of  bonds  dependent  upon  the  amount 
of  its  capitalization,  and  to  deposit  these  bonds 
in  trust  with  the  Treasurer  of  the  United  States. 
Upon  so  doing,  the  bank  was  permitted  to  receive 
bank  notes  to  an  equal  amount,  and  could  then  dis- 
pose of  these  as  it  pleased,  using  them  in  loans  to 
borrowers.  Should  the  bank  fail,  the  notes  could 
be  provided  for  by  selling  the  bonds  and  thus 
establishing  a  fund  for  their  cancellation.  The 


262        LOANS   AND    INVESTMENTS 

Federal  Reserve  Act  repealed  the  provision  re- 
quiring such  purchases  of  bonds  by  banks.  Inas- 
much as  United  States  bonds  have  always  been  of 
high  standing  in  the  market  since  the  system  of 
note  issue  referred  to  was  first  established,  there 
has  never  been  a  time  when  anyone  felt  the  slight- 
est question  about  the  ultimate  goodness  of  the 
National  bank  note.  This  very  secure  character 
has,  however,  been  obtained  at  considerable  cost, 
since  the  use  of  United  States  bonds  has  rendered 
it  very  difficult  to  get  the  notes  into  circulation 
when  they  were  wanted  and  conversely  has  made 
it  hard  to  retire  them  when  they  were  not  wanted. 
230.  STATUS  OF  AMERICAN  NOTE  CUR- 
RENCY.— It  has  been  a  principal  cause  of  com- 
plaint of  the  existing  currency  situation  in  the 
United  States  for  many  years  past  that  our  medium 
contained  no  element  corresponding  to  what  is 
known  as  the  "elastic"  bank  note  issues  of  other 
countries.  There  have  been  many  kinds  of  cur- 
rency in  circulation,  the  principal  being  as  follows : 

(1)  United  States  notes  or  greenbacks,  legal 
tender  in  payment  of  debts. 

(2)  Gold  certificates  representing  actual  gold 
coin  held  as  a  trust  fund  in  the  Treasury. 

(3)  Silver  certificates  representing  silver  coin 
held  as  a  trust  fund  against  them  in  Washington. 

(4)  Currency  certificates  representing  United 
States  notes  held  as  a  trust  fund  in  Washington  or 
at  sub-treasuries  to  facilitate  bank  exchange. 


LOANS   AND   INVESTMENTS        263 

(5)  Gold  coin,  legal  tender  in  payment  of  debts. 

(6)  Silver  dollars,  legal  tender  in  payment  of 
debts. 

(7)  Silver  subsidiary  coin,  legal  tender  in  pay- 
ment of  debts  up  to  $5. 

(8)  Minor  coins  of  limited  legal  tender  quality. 

(9)  National  bank  notes  issued  by  the  banks 
and  protected  by  Government  bonds  deposited  with 
the  Treasury  Department. 

231.  INELASTICITY  OF  CURRENCY.— It 
is  easily  seen  that  of  all  these  classes  of  currency 
and  money  which  have  been  in  circulation  none 
could  be  increased  save  by  the  actual  bringing  of 
metal  to  the  mint  for  coin,  with  the  exception  of 
National  bank  notes.  The  latter  could  be  enlarged 
in  volume  by  the  deposit  of  Government  bonds  and 
the  placing  of  a  5  per  cent,  redemption  fund  with 
the  Treasury  Department.  Even  in  the  latter  case, 
however,  it  is  clear  that  the  amount  of  National 
bank  notes  which  could  be  issued  was  limited  in 
the  aggregate  amount  by  the  total  volume  of  United 
States  bonds  in  existence,  and  was  still  further 
limited  by  the  fact  that  many  such -bonds  were  held 
and  used  to  protect  public  deposits,  while  still 
others  were  held  by  investors,  and  so  were  not1 
available  for  circulation  purposes.  As  the  National 
bank  currency  had  increased  in  amount  until  it 
absorbed  practically  all  of  the  available  volume  of 
bonds,  it  has  been  apparent  at  certain  times  in  the 
past  that  a  great  demand  for  notes  could  not  be 


264        LOANS   AND    INVESTMENTS 

satisfied  by  the  taking  out  of  bank  currency.  In 
order  to  overcome  the  "inelasticity"  of  practically 
every  element  in  the  currency  system  various  plans 
have  been  proposed. 

232.  SUFFICIENCY  OF  PROTECTION.— 
The  experience  of  other  countries  and  the  theory 
of  banking  both  combined  to  indicate  that  there  is 
no  sound  reason  for  differentiating  between  the 
protection  accorded  to  notes  and  that  accorded  to 
deposits;  but  that  which  is  sufficient  in  one  case 
should  be  sufficient  in  all  others,  and  that  this  (as 
the  experience  of  our  nation  indicates)  should  be 
the  best  constituent  of  the  assets  of  the  banks— 
namely,  sound,  short  time  commercial  paper.  The 
difficulty  in  applying  this  standard  has  been  two- 
fold. 

(1)  It  has  been  contended  that  there  was  not 
sufficient  sound  paper  of  the  kind  required  in  the 
United  States. 

(2)  It  has  been  urged  that  existing  bank  notes 
could  not  be  displaced  on  account  of  the  injustice 
to  the  banks  which  had  bought  bonds  to  deposit 
as  security  for  the  notes,  and  for  other  reasons. 
The  problem,  therefore,  of  those  who  wished  to  in- 
troduce a  more  satisfactory  method  of  issuing  new 
currency  has  been  that  of  protecting  the  owners 
of  existing  bonds  and  at  the  same  time  of  furnishing 
an  adequate  basis  for  new  note  issues  in  the  shape 
of  undoubtedly  sound  commercial  paper.   To  attain 
these  objects  there  have  been  many  complicated 


LOANS   AND    INVESTMENTS        265 

plans  in  the  past,  and  an  additional  element  of  com- 
plexity has  been  added  by  reason  of  the  attempt 
usually  made  to  introduce  special  means  of  insuring 
the  safety  and  goodness  of  the  notes. 

233.  NOTES  UNDER  THE  FEDERAL  RE- 
SERVE  ACT.— When  the  Federal  Reserve  Act 
was  in  process  of  drafting,  all  these  considerations 
were  taken  under  advisement,  and  it  was  thought 
best  to  provide  for  the  proper  treatment  of  existing 
note  currency  as  well  as  for  the  issue  of  new  notes. 
Originally  the  Federal  Reserve  Act  provided  for 
the  refunding  of  existing  bonds — that  is  to  say, 
the  exchange  of  the  bonds  now  outstanding  for 
new    bonds    to    bear  three    per    cent,    interest, 
and    the    gradual    retirement    of    National    bank 
currency  as  this  refunding  proceeded.    Provision 
was  also  made  for  the  issue  of  bank  notes  by 
the  several  Reserve  banks  based  upon  the  deposit 
of  commercial  paper  of  the  kind  made  eligible  for 
rediscount  under  the  terms  of  the  laws;  and  the 
general  purpose  contemplated  by  the  measure  was 
that  in  the  course  of  twenty  years  existing  National 
bank  notes  should  be  retired,  and  new  Federal  Re- 
serve notes  should  take  their  place. 

234.  CLASSES  OF  NOTES.— While  the  Act 
was  under  consideration  in  Congress  alterations 
were  introduced  into  it,  and  the  machinery  by  which 
the  purposes  of  the  Act  were  to  be  fulfilled  was 
altered,  although  it  may  be  broadly  said  there  was 
no  change  in  the  objects  ultimately  aimed  at.    Prob- 


266        LOANS   AND    INVESTMENTS 

ably  the  most  important  alteration  thus  made  in 
the  terms  of  the  law  was  that  which  designated 
the  new  Federal  Reserve  notes  as  obligations  of 
the  United  States,  thus  making  them,  in  the  techni- 
cal sense  at  least,  a  Government  currency.  Another 
important  innovation  was  a  provision  whereby 
Federal  Reserve  banks  might  be  required  by  the 
Federal  Reserve  Board  to  buy  National  bonds  held 
by  member  banks  at  a  rate  not  to  exceed  $25,000,000 
per  annum,  while  they  were  to  be  permitted  to  issue 
a  new  kind  of  currency  to  be  known  as  Federal 
Reserve  bank  notes  on  the  strength  of  the  bonds 
which  they  thus  acquired.  It  will  be  seen  that  the 
Act,  therefore,  provides  for  two  new  classes  of 
currency: 

(1)  Federal  Reserve  notes. 

(2)  Federal  Reserve  bank  notes. 

The  former  are  protected  by  commercial  paper  of 
the  kind  rendered  eligible  for  rediscount  under  the 
terms  of  the  law;  the  latter  are  protected  by  Na- 
tional bonds  purchased  from  the  member  banks 
of  the  System,  or  any  other  Government  bonds 
having  circulation  privileges.  The  ultimate  form 
of  the  Federal  Reserve  Act,  however,  provides  for 
the  conversion  of  two  per  cent,  bonds  into  three 
par  cent,  bonds  by  Federal  Reserve  banks;  such 
three  per  cent,  bonds,  moreover,  to  lose  their  privi- 
lege of  deposit  with  the  Government  to  protect 
circulation. 

235.    PROCESS  OF  CONVERSION.— It  will 


LOANS   AND    INVESTMENTS        267 

thus  be  seen  that,  under  the  terms  of  the  Federal 
Reserve  Act,  the  natural  development  would  be 
conversion  in  a  period  of  years  of  most  of  the 
National  bank  notes  into  Federal  Reserve  bank 
notes,  with  accompanying  retirement  of  these 
notes,  through  the  conversion  of  the  two  per  cent, 
bonds  protecting  them,  into  three  per  cent,  bonds; 
while,  in  the  meantime,  Federal  Reserve  notes  based 
on  commercial  paper  would  be  issued  from  time  to 
time  as  demanded,  in  quantities  sufficient  to  supply 
the  elastic  element  in  currency,  and  to  fill  up  such 
gaps  in  existing  National  bank  notes  as  might  be 
caused  through  the  retirement  of  note  issues  due 
to  the  conversion  of  two  per  cent,  into  three  per 
cent,  bonds  not  bearing  the  circulation  privilege. 

236.  DEMAND  FOR  NOTES.— It  is  now 
time  to  see  how  this  technical  proceeding  works 
in  practice,  and  what  will  be  the  effect  of  it  upon 
the  average  man  the  country  over.  Let  us  first 
observe  with  some  care  exactly  what  gives  rise  to 
a  demand  for  currency  and  to  consequent  issues  of 
Federal  Reserve  notes.  When  A  trades  with  B 
to  the  extent  of  $100,000  worth  of  goods  he  thereby 
creates  a  demand  for  some  means  of  transferring 
the  value  of  $100,000.  This  exchange  may  be  made 
by  the  actual  use  of  money,  or  by  the  drawing  of 
a  check.  Where  the  buyer  of  the  goods  does  not 
have  the  means  to  pay  for  them  he  usually  applies 
to  his  bank  for  accommodation,  and  such  bank  may 
meet  his  requirements^  by^giving  him  a  credit  on 


268        LOANS    AND    INVESTMENTS 

its  books,  technically  known  as  a  "deposit,"  or  by 
issuing  to  him  its  own  notes  or  the  equivalent  there- 
of. There  is  no  reason  why  the  bank  which  is  thus 
applied  to,  if  it  desires  to  grant  the  credit  at  all, 
should  not  give  the  accommodation  in  either  form 
that  may  be  desired  by  the  customer.  The  cus- 
tomer is  likely  to  be  governed  entirely  by  the 
demand  of  the  people  with  whom  he  is  dealing  as 
to  the  form  of  payment  required.  In  the  case  of  the 
bill  of  goods  for  $100,000  already  spoken  of,  it  is 
probable  that  a  check  on  the  bank  would  be  exactly 
what  he  wanted,  in  which  case  no  question  of  note 
issue  is  raised.  But  it  may  also  be  that  the  funds 
are  not  wanted  for  a  single  payment  of  this  kind, 
but  that  accommodation  is  sought  for  some  purpose 
which  necessitates  a  number  of  small  payments  to 
persons  who  do  not  or  cannot  employ  bank  checks. 
In  this  instance  notes  would  be  needed.  Or  it  may 
happen  that  a  bank  discounts  some  paper  for  the 
purpose  of  obtaining  currency  with  which  to  supply 
actual  calls  for  currency  made  by  its  customers  who 
are  not  necessarily  borrowers  but  who  want  notes 
to  carry  in  their  pockets  for  the  purpose  of  meeting 
demands  from  day  to  day. 

237.  NOTES  AS  NEEDED.— What  the  Fed- 
eral Reserve  Act  does  is  to  permit  a  bank  to  take 
the  promises  of  individuals  to  pay  at  the  end  of  a 
designated  period,  indorse  these  promises  with  its 
own  signature,  and,  by  the  deposit  of  them  with 
the  Federal  Reserve  bank,  obtain  in  exchange 


LOANS   AND    INVESTMENTS        269 

Federal  Reserve  notes  issued  to  that  bank  by  a 
Government  officer  known  as  a  Federal  Reserve 
Agent.  The  fact  that  these  notes  are  technically 
obligations  of  the  Government  confuses  the  situa- 
tion to  some  extent,  because  it  makes  the  transac- 
tion appear  as  if  it  were  one  which  involved  the 
Government  in  some  way.  As  a  matter  of  fact, 
it  is  the  member  bank's  demand  which  gives  the 
signal  for  the  issue  of  the  notes  and  determines  how 
many  of  them  shall  come  out;  while  it  is  the 
demand  of  the  customer  of  the  member  bank  which 
influences  the  action  of  that  bank  in  applying  for 
them.  Ultimately  and  in  broadest  terms,  then,  the 
provision  of  the  Federal  Reserve  Act  simply  allows 
individuals  to  make  their  own  obligations  based  on 
commercial,  industrial  or  agricultural  transactions, 
and  then,  by  putting  these  through  a  local  bank,  to 
get  note  currency  corresponding  thereto.  As  long 
as  their  credit  is  good  they  can  get  the  notes,  pro- 
vided that  the  Federal  Reserve  bank  is  in  a  position 
to  protect  these  notes  amply  with  gold.  Under  the 
terms  of  the  Federal  Reserve  Act  this  protection 
must  amount  to  at  least  40  per  cent,  of  the  face  of 
the  note  issue;  and  of  this  40  per  cent,  five  per 
cent,  is  deposited  with  the  Treasury  Department 
for  current  redemption,  the  other  35  per  cent,  being 
held  in  the  vaults  of  the  Federal  Reserve  bank 
which  issues  the  notes.  The  currency  is  thus  elastic, 
inasmuch  as  it  can  be  increased  to  the  extent  of 
two  and  one-half  times  the  supply  of  gold  available 


270        LOANS   AND   INVESTMENTS 

— 100  per  cent,  being  two  and  one-half  times  40 
per  cent. — while  it  is  safe,  inasmuch  as  the  protec- 
tion is  adequate  for  all  ordinary  requirements. 
Nothing  limits  the  amount  of  notes  that  can  be 
issued,  therefore,  except  the  needs  of  the  business 
community  and  the  adjustment  of  the  country's 
gold  supply  to  that  of  other  nations. 

238.  FEDERAL  RESERVE  BANK  NOTES. 
— The  Federal  Reserve  bank  note  differs  from  the 
Federal  Reserve  note  in  that  it  is  based  upon 
Government  bonds  which  are  deposited  with  the 
Treasury  Department  to  safeguard  it,  just  as  is 
the  case  with  National  bank  notes.  The  Federal 
Reserve  bank,  under  the  provisions  of  the  Federal 
Reserve  Act,  is.  permitted  to  buy  Government  bonds 
as  a  form  of  investment  if  it  chooses  to  do  so.  In 
addition  to  this,  Federal  Reserve  banks  in  the  ag- 
gregate may  be  assigned  by  the  Board  Govern- 
ment bonds  to  an  amount  not  to  exceed  $25,000,000 
per  annum,  and  may  be  required  to  purchase  them 
and  pay  for  them  at  par.  Such  assignment  takes 
place  only  in  the  event  that  member  banks  desiring 
to  sell  their  bonds  file  application  with  the  Treasury 
Department  for  the  disposal  of  these  bonds  and  the 
retirement  of  circulation  based  thereon.  If  the 
aggregate  of  such  applications  should  be  more  than 
$25,000,000  per  annum,  the  Federal  Reserve  Board 
apportions  the  purchases  among  the  banks  by  a 
method  prescribed  in  the  law,  which  amounts  to  a 
distribution  according  to  capital  and  surplus.  In- 


LOANS   AND    INVESTMENTS        271 

asmuch  as  the  banks  which  thus  seek  to  exchange 
their  bonds  are,  of  course,  unable  to  get  back  the 
notes  that  were  issued  on  these  bonds  (the  latter 
being  in  circulation  throughout  the  country),  this 
provision  of  the  law  amounts  to  permitting  the 
member  banks  to  transfer  to  the  Federal  Reserve 
banks  up  to  the  amount  of  $25,000,000  a  year,  such 
Government  bonds  with  the  circulation  privilege 
as  they  may  have  in  their  possession  pledged  to 
secure  National  bank  notes,  the  Federal  Reserve 
banks  becoming  thereupon  obligated  for  all  out- 
standing National  bank  notes  previously  issued 
against  them.  Of  course,  the  transaction  would 
not  occur  in  precisely  this  way,  as  the  Federal 
Reserve  bank  would  pay  for  the  bonds,  and  the 
money  would  go  into  the  Treasury,  there  to  be  held 
against  the  outstanding  bank  notes  which  had  been 
issued  on  the  strength  of  these  bonds.  The  Federal 
Reserve  bank  would  then  be  able  to  issue  its  own 
notes  against  the  bonds  so  taken  over  if  it  saw  fit, 
as  it  doubtless  would;  but  the  result  would  be 
the  same. 

239.  TIME  OF  RETIREMENT.— It  is  easy 
to  see  that  if  this  process  went  on  for  about  thirty 
years  at  the  rate  of  $25,000,000  per  annum,  all  of 
the  National  bonds  would  have  been  taken  over  by 
the  Federal  Reserve  banks,  the  National  bank  notes 
based  thereon  retired,  and  an  equal  amount  of 
Federal  Reserve  notes  issued  in  their  place.  We 
should  then  have  this  underlying  sub-structure  of 


272        LOANS   AND   INVESTMENTS 

Federal  Reserve  bank  notes  (or,  in  the  interim,  of 
Federal  Reserve  bank  notes  and  National  bank 
notes  combined) ;  while  above  would  be  a  super- 
structure of  Federal  Reserve  notes  based  on  re- 
discounted  commercial  paper,  and  varying  in 
amount  according  to  the  needs  of  the  country.  How 
great  are  such  needs?  They  are,  of  course,  only 
temporary  and  exceptional,  inasmuch  as  the  regu- 
lar, steady,  permanent  demands  are  met  by  the 
underlying  structure  of  bond-secured  notes.  These 
varying  demands  are  in  part  the  result  of  so-called 
"seasonal"  calls,  for  the  moving  of  crops  and  the 
like,  and  in  part  the  result  (at  special  times)  of 
so-called  "panic"  demands.  There  is  no  positive 
information  as  to  the  actual  amount  of  the  seasonal 
demands  for  crop  moving.  They  vary  greatly ;  and 
as  long  as  there  is  in  existence  a  large  underlying 
body  of  notes,  there  will  always  be  more  or  less 
shipment  of  currency  from  one  part  of  the  country 
to  another  to  meet  seasonal  calls. 

240.  PANIC  DEMANDS  FOR  CURRENCY. 
— The  extent  of  the  panic  demands  can  be  estimated 
on  the  basis  of  experience  obtained  during  the 
autumn  of  1914.  At  that  time  calls  were  made  on 
the  Treasury  Department  under  the  section  of  the 
Federal  Reserve  Act  which  extended  the  operation 
of  the  so-called  Aldrich-Vreeland  Law  through 
local  "currency  associations,"  for  sums  aggregating 
about  $386,000,000.  This  was  the  result  of  an 
extremely  severe  currency  demand,  and  under  no 


LOANS    AND    INVESTMENTS        273 

ordinary  conditions  would  again  be  witnessed.  If 
we  estimate  the  ordinary  normal  seasonal  demands 
at  one-third  of  this  amount,  it  would  probably  be 
an  amply  high  figure.  It  may  be  stated,  then,  that 
when  the  Reserve  System  is  in  full  operation  there 
may  be  a  call  for  from  $125,000,000  to  $375,000,000 
of  Federal  Reserve  notes,  the  amount  varying  ac- 
cording to  conditions.  At  the  end  of  1915  there 
were  outstanding  about  $214,000,000  of  Federal 
Reserve  notes,  while  of  this  amount  all  except  some 
$16,700,000  was  protected  by  deposits  of  gold  or 
lawful  money  dollar  for  dollar.  There  can  be  no 
doubt  that  the  quantity  of  legitimate  commercial 
paper  in  current  existence  is  ample  to  sustain  even 
the  maximum  demand  for  currency  thus  indicated, 
so  that  it  may  truly  be  said  that  the  Federal  Reserve 
System  is  fully  able  to  supply  an  elastic  currency 
issued  to  any  reasonable  amount  that  may  be  called 
for.  The  only  limitation  upon  the  currency  is  the 
demand  of  the  community  and  the  existence  of 
actual  live  transactions  calling  for  it. 

241.  POLICY  OF  NOTE  ISSUE.— Many  who 
speak  of  the  currency  question  seem  to  think  that 
it  is  desirable  for  the  Federal  Reserve  banks  to 
force  out  into  circulation,  and  to  keep  out,  as  large 
a  volume  of  circulating  notes  as  possible,  obtaining 
in  exchange  therefor  the  gold  of  the  community. 
Thus  it  is  often  argued  that  it  would  be  desirable 
to  permit  member  banks  to  count  Federal  Reserve 
notes  as  reserves  in  their  own  vaults,  the  effect 


274        LOANS   AND   INVESTMENTS 

being  to  make  them  willing  to  hold  the  notes  there, 
and  to  deposit  their  cash  means  with  the  Federal 
Reserve  bank,  which  in  turn  would  use  these  means 
as  a  reserve  basis  protecting  other  liabilities — notes 
and  deposit  accounts.  Such  a  view,  of  course, 
ignores  the  theory  upon  which  the  Federal  Reserve 
Act  is  founded — the  so-called  "banking  theory," 
as  opposed  to  the  "currency  theory."  The  banking 
theory  implies  that  notes  are  put  into  circulation 
simply  for  the  purpose  of  facilitating  the  exchange 
of  goods,  and  that  when  this  purpose  has  been 
fulfilled  they  should  pass  out  of  existence.  Bank 
notes,  according  to  this  view,  are  not  a  means  of 
displacing  gold  and  enabling  the  hoarding  of  the 
latter  metal,  but  are  a  means  of  providing  a  sub- 
stitute for  gold  for  the  purpose  of  making  ex- 
changes, such  substitute  to  continue  in  use  so  long 
as  there  is  an  actual  demand  for  it  for  the  transfer 
of  goods,  and  then  to  go  out  of  use  as  soon  as  this 
demand  has  been  satisfied. 

242.  FEDERAL  RESERVE  NOTES  AND 
BANK  RESERVES.— It  is  often  pointed  out  that 
the  Federal  Reserve  notes,  not  being  legal  tender 
and  not  being  reserve  money,  can,  at  the  will  of  the 
holder  (if  a  bank)  be  promptly  converted  into 
reserve  funds  by  the  simple  process  of  depositing 
them  with  the  Federal  Reserve  bank  which  issued 
them.  Therefore,  it  is  argued,  the  wise  course 
would  be  that  of  making  the  Reserve  note  legal 
tender  to  start  with,  and  of  permitting  it  to  be  used 


LOANS   AND   INVESTMENTS        275 

in  bank  reserves.  No  such  conclusion  can,  however, 
fairly  be  drawn.  When  the  Federal  Reserve  note 
is  deposited  with  the  Federal  Reserve  bank  which 
issues  it,  and  is  thereby  converted  into  a  deposit 
credit  (reserve),  the  Federal  Reserve  bank  is  given 
a  means  of  tracing  and  accounting  for  its  liabilities 
at  every  step.  The  bank  knows  when  the  deposit 
credit  is  cancelled,  and  how  effectively  and  under 
what  conditions  it  is  transferred.  It  has  entire 
control  of  its  own  liabilities  in  this  regard.  The 
reserve  deposits  are  not  legal  tender,  but  they  are 
reserves  for  the  member  banks.  The  member  banks 
must  provide  a  legal  tender  for  their  own  cus- 
tomers, but  for  their  own  use  they  have  their  credits 
on  the  books  of  the  Federal  Reserve  bank.  This 
is  a  situation  totally  different  in  theory  from  that 
which  would  grow  out  of  a  plan  such  as  that  put 
forward  in  the  Aldrich  or  Monetary  Commission 
bill — whereby  the  notes  of  the  reserve  institutions 
were  made  legal  tender,  and  available  in  the  mem- 
ber bank  reserves.  Under  those  circumstances 
there  would  have  been  nothing  whatever  to  pro- 
duce elasticity. 

243.  NOTES  BASED  UPON  BUSINESS 
TRANSACTIONS.— The  note  issue  on  its  new 
basis  will,  however,  be  highly  elastic  and  con- 
trollable. There  can  be  no  question  of  its  sound- 
ness and  convertibility,  and  none  of  its  flexibility. 
It  is  perhaps  the  most  conspicuous  feature  of  the 
new  banking  system,  because  the  one  that  has  been 


276        LOANS   AND   INVESTMENTS 

most  discussed,  but  it  is  far  from  being  the  most 
important,  in  view  of  the  fact  that  the  law,  as 
already  stated,  accepts  the  banking  theory  of  note 
issue  rather  than  the  so-called  currency  theory. 
"No  note  issue  without  a  transaction  to  call  for  it" 
is  the  first  principle  upon  which  the  Federal  Reserve 
note  issue  is  based.  "No  commercial  transaction 
that  cannot  obtain  a  note  issue  to  facilitate  it"  is 
the  second  principle.  Taken  together,  they  imply 
that  the  business  community  need  not  in  the  future 
fear,  under  any  conditions  reasonable  to  expect,  a 
deficiency  in  the  circulation. 

244.  TAKING  OVER  GOVERNMENT 
BONDS.— The  question  exactly  how  the  Federal 
Reserve  banks  are  to  proceed  in  taking  over  the 
bonds,  and  the  policy  of  the  Treasury  Department 
in  effecting  this  great  transformation  of  the  cur- 
rency of  the  country,  is  a  matter  of  profound  inter- 
est to  the  banker,  not  only  from  the  general  stand- 
point of  theory,  but  also  as  a  matter  of  affecting 
the  value  of  his  assets.  More  than  seven  hundred 
millions  of  dollars  of  Government  bonds  are  now 
held  by  the  National  banks  of  the  country  for  the 
purpose  of  sustaining  their  outstanding  notes.  The 
great  bulk  of  Government  bonds  now  in  existence 
are  not  of  the  type  which  are  attractive  to  the 
public  from  the  investment  standpoint,  and  it  is 
fair  to  say,  as  a  general  matter,  that  they  could  not 
be  sold  to  private  persons,  but  must  be  held  by 
banking  institutions  for  the  most  part.  Under  the 


LOANS    AND    INVESTMENTS        277 

Federal  Reserve  Act  there  are  two  methods  by 
which  the  National  banks  now  holding  these  bonds 
may  be  gradually  relieved  of  them: 

(1)  Purchases  by  Federal  Reserve  banks  in  the 
"open  market" — that  is  to  say,  purchases  from  any 
individual   or  institution  from  whom  they  may 
choose  to  buy. 

(2)  Assignments  or  allotments  to  the  Federal 
Reserve  banks  made  by  action  on  the  part  of  the 
Federal  Reserve  Board,  in  approving  applications 
for  the  sale  of  bonds  ttp  to  $25,000,000  which  are 
filed  with  the  Treasurer  of  the  United  States  by  the 
banks  now  owning  these  bonds. 

245.  PROBLEMS  OF  CONVERSION.— In 
connection  with  the  administration  of  the  act, 
several  matters  of  a  serious  nature  have  called  for 
attention.  One  is  the  Tfact  that  the  act  permits 
Federal  Reserve  banks  to  go  much  further  than 
their  allotment  of  $25,000,000  annually  in  th'e  pur- 
chase of  bonds,  so  that  the  question  has  arisen,  how 
far  it  would  be  wise  to  take  over  bonds  through 
actual  purchase.  Another  question  calling  for  dis- 
position has  been  whether  such  purchases  would 
constitute  a  reduction  of  the  amount  that  might  be 
allotted  to  them  by  the  Board.  The  Federal  Re- 
serve Board,  in  passing  upon  this  question,  has 
taken  the  view  first  of  all,  that  actual  purchases 
made  by  the  Reserve  banks  might  be  counted  as 
reducing  the  amount  that  could  be  allotted  to  them 
as  the  result  of  applications  for  sale  made  by  the 


278        LOANS   AND    INVESTMENTS 

member  banks  through  the  Treasurer  of  the  United 
States.  A  matter  which  has  been  of  great  import- 
ance from  the  standpoint  of  the  Reserve  banks  has 
been  whether  such  bonds  as  they  take  over,  either 
through  purchase  or  allotment,  could  be  immedi- 
ately converted  into  three  per  cent,  bonds  by  the 
Treasury  Department,  or  whether,  under  the  terms 
of  the  law,  they  must  be  partly  converted  into 
one-year  notes,  and  whether  the  conversion  might 
go  on  to  any  amount  that  the  banks  chose  to 
demand.  The  decision  reached  by  the  authorities 
of  the  Treasury  Department  has  been  that  it  lay 
within  the  jurisdiction  of  the  Department  to  deter- 
mine the  amount  of  bonds  so  to  be  converted,  and 
the  proportions  in  which  the  conversion  should  be 
made  into  long  term  bonds  and  one-year  notes. 
For  the  first  year  it  was  determined  to  convert 
only  $30,000,000  of  the  existing  bonds  and  to  make 
this  conversion  as  nearly  as  possible  into  equal 
portions  of  long  term  three  per  cent,  bonds  and 
one-year  three  per  cent,  notes.  The  aggregate,  as 
well  as  the  division  between  bonds  and  notes,  may 
be  varied  from  year  to  year  at  the  discretion  of  the 
Secretary  of  the  Treasury. 

246.  CURRENCY  AND  BANK  RESERVES. 
— Paul  M.  Warburg,  in  an  address  at  the  Conven- 
tion of  the  American  Bankers  Association,  held  in 
Kansas  City  in  1916,  said  in  part: 

(1)  "Monetary  and  banking  reform  made  its  greatest 
step  forward  when  public  opinion  recognized  that  it  was  not 


LOANS   AND   INVESTMENTS        279 

essentially  a  question  of  note  issues  but  one  of  reserves. 
But,  though  this  reserve  problem  has  thus  been  before  us 
for  many  years,  it  is  a  strange  fact  that  there  still  exists  a) 
singular  confusion  in  the  minds  of  bankers,  writers  and; 
students  as  to  what  the  word  'reserve'  actually  means  in  this 
connection.  There  are  all  kinds  of  reserves.  There  are 
military  and  naval  reserves.  We  speak  of  reserves  in  deal- 
ing with  water  supply,  with  food,  raw  materials,  rolling 
stock,  electric  power,  and  what  not.  In  each  case  its  mean- 
ing depends  upon  the  requirements  of  the  organization 
maintaining  the  reserve.  Reserve  is,  as  the  name  implies, 
what  one  holds  back.  It  generally  means  an  extra  supply 
of  something  kept  idle  for  the  purpose  of  being  immediately 
available  to  take  care  of  an  increased  demand  in  excess  of 
normal  requirements.  Now,  if  we  wish  to  get  a  clear  con- 
ception of  the  meaning  of  reserves  in  connection  with  the 
Federal  Reserve  System,  we  must  understand  that  it  is 
necessary  to  recognize  central  banks  as  entirely  different 
organizations  from  commercial  banks  and  trust  companies 
and,  consequently,  that  their  respective  reserves  differ  as 
much  as  those  of  an  ice  factory  and  a  summer  hotel — the 
one  a  producer  and  the  other  a  consumer  of  ice.  Reserves 
of  central  banks  and  reserves  of  the  general  stock  banks, 
are  two  entirely  different  things.  For  the  sake  of  greater 
simplicity  I  shall  in  this  address  call  the  National  banks, 
State  banks  and  trust  companies,  the  'stock  banks'  and  their 
reserves  'banking  reserves/  and  I  shall  term  the  reserves  of 
the  central  banks  'gold  reserves,'  leaving  it  open  at  this 
point  whether  or  not  these  latter  reserves  should  include 
silver  and  greenbacks.  The  Federal  Reserve  System  is  a 
co-ordination  of  twelve  central  banks  and  the  same  principle 
as  to  reserves,  therefore,  applies  as  if  we  were  dealing  with 
one  central  bank.  I  shall,  therefore,  in  this  address,  class 
the  Federal  Reserve  System  with  the  central  banks. 
(2)  "Let  us  consider  first  the  functions  of  the  stock 


280        LOANS  AND   INVESTMENTS 

banks  in  central  bank  countries.  Deposit  banking  is  the  art 
of  wisely  employing  the  depositors'  stored-up  purchasing 
power.  It  is  based  on  the  principle  that  there  is  a  sufficient 
variety  of  conditions  amongst  the  depositors  and  borrowers 
of  a  bank  so  as  normally  to  preclude  the  probability  of  the 
depositors  withdrawing  and  using  their  own  money  faster 
than  it  can  be  collected  from  the  borrowers  to  whom  tho 
depositors'  purchasing  power  temporarily  has  been  trans- 
ferred. The  bank's  own  capital  and  the  uninvested  part  of 
its  deposits  from  the  insurance,  or  reserve,  fund  to  act  as 
an  equalizer  in  balancing  these  scales.  It  is  essentially  a 
question  of  exchanging  credits  and,  where  there  is  a  central 
banking  machinery  enabling  the  stock  banks  to  liquidate  a 
sufficient  amount  of  their  assets  to  make  good  any  deficits 
that  may  occur,  the  whole  system  is  safe  and  complete.  The 
central  banking  organization  provides  the  member  banks 
either  with  balances  to  be  used  in  the  clearing,  or,  if  currency 
should  be  required,  with  notes  which  will  be  accepted  by 
their  depositors  in  settlement  of  the  stock  bank's  obligations. 
In  countries  where  these  notes  of  the  central  banks  are 
generally  accepted  in  settlement  of  debts  by  business  men 
and  banks,  the  'banking  reserves'  of  the  stock  banks  may 
safely  consist  of  the  central  bank  currency  or  of  a  balance 
kept  with  the  central  bank  convertible  into  such  currency. 
These  form  the  first  line  of  banking  reserves.  The  second 
line  consists  of  those  assets  which,  with  certainty  and 
promptness,  may  be  converted  into  credit  balances  with  the 
central  bank.  It  is  simply  a  question  of  having  a  reserve  of 
such  credit  currency,  or  of  power  to  produce  such  credit 
balances,  as  will  provide  an  acceptable  means  of  satisfying 
depositors.  Balances  with  the  central  bank,  and  its  notes, 
entitle  the  stock  banks,  like  any  other  holder,  to  payment 
in  legal  tender ;  and  if  legal  tender  is  demanded  by  creditors 
o£  the  stock  banks,  the  latter  must  rely  upon  the  central 
bank  to  furnish  it.  The  duty  to  keep  its  own  deposit  and 


LOANS   AND   INVESTMENTS        281 

note  obligations  sufficiently  protected  by  a  proper  propor- 
tion of  metallic  cover  rests  with  the  central  bank,  and  its 
reserves,  therefore,  must  consist  exclusively  of  the  metal  in 
which  its  obligations  are  payable.  In  central  bank  countries 
there  does  not  exist  any  law  that  requires  stock  banks  to 
keep  in  actual  specie  in  their  own  vaults  a  certain  proportion 
of  their  deposits.  All  the  central  bank  usually  requires  is 
that  the  stock  banks  and  other  firms  maintain  with  it  free 
balances  commensurate  with  the  scope  of  their  transactions. 
As  a  matter  of  fact,  if  we  study  the  statements  of  European 
stock  banks  we  find  one  single  cash  item  which  includes 
the  combined  holding  of  gold,  silver,  bank  notes  and  the 
balance  with  the  central  bank. 

(3)  "In  the  United  States  our  old  State  banking  systems 
did  not  provide  for  any  central  organization  to  protect  the 
banks'  gold  obligations,  nor  did  they  furnish  the  machinery 
by  which,  in  case  of  need,  banks  could  convert  their  com- 
mercial assets  into  cash  or  credit  balances.  The  National 
Bank  Act,  therefore,  required  every  National  bank  to  main- 
tain against  its  deposits  a  certain  percentage  of  actual  »lawful 
money  reserve,  which  it  was  considered  should  constitute  its 
contribution  to  the  general  gold  protection  of  the  nation ;  in 
addition,  credit  bank  balances  in  reserve  and  central  reserve 
cities  were  to  provide  a  certain  liquidity  in  case  of  emerg- 
encies. The  vicious  shortcomings  of  this  old  method  are 
well  known  to  everybody  here,  and  need  not  be  elaborated. 
The  Federal  Reserve  Act  brought  about  a  most  radical 
change.  It  created  a  system  of  twelve  central  banks  which, 
co-operating  with  one  another,  were  from  then  on  to  exercise 
two  important  functions  in  relation  to  their  member  banks ; 
first,  to  provide  a  sufficient  gold  cover  for  the  country's  gold 
obligations ;  and,  second,  to  provide  the  machinery  for  turn- 
ing, whenever  desired,  the  member  banks'  commercial  assets 
into  available  credit  balances  or  cash.  The  first  function 
relieved  the  member  banks  of  the  necessity  of  keeping  in 


282        LOANS    AND    INVESTMENTS 

their  vaults  large  amounts  of  gold  for  the  general  protection 
of  the  country;  the  second  rendered  unnecessary  the  so- 
called  reserve  balances  with  correspondents  in  reserve  and 
central  reserve  cities.  The  safe  and  effectual  transfer  of 
these  burdens  to  the  Federal  Reserve  banks  must  be  predi- 
cated, however,  upon  a  sufficient  mobilization  and  concen- 
tration of  gold  in  the  hands  of  the  Federal  Reserve  banks, 
and,  furthermore,  upon  the  existence  of  a  large  volume  of 
standardized  commercial  and  banking  paper,  easily  redis- 
countable  without  red  tape  with  the  Federal  Reserve  banks. 
This  is  where  the  Federal  Reserve  Act  stopped  half-way. 
It  did  not  say  to  the  member  banks,  'Maintain  with  the 
Federal  Reserve  bank  a  minimum  balance  sufficient  for  the 
general  safety  of  the  country  and  whatever  cash  you  keep 
in  excess  of  that  in  your  own  vaults — be  that  gold  or  silver 
or  Federal  Reserve  notes — is  your  own  concern.  But  bear 
in  mind  that  the  larger  the  gold  fund  produced  by  the  com- 
bined contributions  from  your  own  vaults,  the  stronger  will 
be  the  protection  to  you  and  the  entire  country.'  The  law 
continued,  instead,  the  anomaly  of  requiring  member  banks 
to  lock  up  in  their  vaults  hundreds  of  millions  of  dollars, 
thus  preventing  them  by  legal  enactment  from  giving  addi- 
tional strength  to  their  own  protective  system,  even  if  they 
should  want  to  do  so.  It  further  created  the  anomalous 
situation  that,  while  a  balance  with  a  Federal  Reserve  bank 
could  be  considered  as  reserve,  the  Federal  Reserve  note 
could  not  be  so  counted,  despite  the  fact  that  it  is  a  prior 
lien  against  the  assets  of  the  bank  and  is  the  obligation  of 
the  United  States,  while  the  balance  is  not.  This  inconsist- 
ency— to  a  certain  extent  at  least — has  been  cured ;  Congress 
having  passed,  upon  the  recommendation  of  the  Board,  a 
most  important  amendment  authorizing  the  Board  to  permit 
member  banks  to  keep  any  portion  of  their  required  vault 
reserve  as  balances  with  their  Federal  Reserve  banks.  In 
passing  this  amendment  Congress  has  opened  the  path  for 


LOANS    AND    INVESTMENTS        283 

great  strides  in  advance,  and  it  remains  to  be  seen  now  how 
far  the  bankers  of  the  United  States  will  be  able  to  seize 
this  opportunity  of  doubling  the  strength  of  their  Federal 
Reserve  banks. 

(4)  "In  dealing  with  the  problem  of  adequate  reserves, 
we  must  first  and  always  consider  the  question  of  whether 
or  not  our  Federal  Reserve  banks  are  sufficiently  strong  for 
the  protection  of  the  country  or  whether  they  are  stronger 
than  necessary.  Whenever  the  latter  question  can  be 
answered  in  the  affirmative,  then  only  will  we  be  justified 
in  considering  the  advisability  of  reducing  the  member 
banks'  reserve  requirements.  What  is  the  Federal  Reserve 
System's  lending  power  today  ?  If  we  set  aside  a  gold  reserve 
of  only  forty  per  cent. — which  may  do  in  times  of  stress,  but 
is  not  a  proper  and  sufficient  basis  in  normal  times — we  find 
that  we  have  a  free  gold  reserve  of  about  $206,000,000,  or  if 
we  include  the  gold  now  held  in  cold  storage  by  the  Federal 
Reserve  agents,  about  $380,000,000.  This  means  that  by 
additional  rediscount  operations,  or  purchases  in  the  open 
market,  for  home  requirements  or  for  export,  we  are  able  to 
stand  a  loss  of  gold  of  from  two  to  three  hundred  million 
dollars.  Two  hundred  million  dollars  is  a  very  large  amount, 
but  when  we  realize  that  the  nation's  gold  holding  in  one 
year  has  increased  by  about  $500,000,000,  it  is  well  for  us  to 
consider  whether  or  not  we  shall  be  able  to  hold  this  gold 
at  the  end  of  the  war.  It  is  impossible  to  predict  what  will 
then  be  our  economic  and  financial  situation.  Perhaps  we 
may  find  ourselves  in  an  overexpanded  or  generally  unsatis- 
factory condition,  and  we  may  have  to  face  a  readjustment 
in  which  all  our  banking  strength  may  be  required.  On  the 
other  hand,  things  may  go  well  with  us,  but  in  the  rest  of  the 
world  there  may  be  a  great  deal  of  financial  distress.  In  that 
case  (and  it  may  be  the  more  likely  of  the  two)  we  shall 
have  almost  boundless  opportunities,  but  serious  obligations 
as  well.  Foreign  loans  in  the  old  and  the  new  world  may 


284        LOANS   AND    INVESTMENTS 

draw  away  our  capital  at  interest  rates  "far  in  excess  of  our 
own.  Our  exporters  will  have  to  meet  the  keen  competition 
of  other  nations,  and  even  though  at  first  there  will  prob- 
ably be  a  strong  demand  for  certain  of  our  raw  materials, 
the  purchasing  power  of  many  a  country  will  be  found 
materially  reduced.  These  are  conditions  which,  in  the  long 
run,  may  be  the  cause  of  heavy  gold  exports  from  the  United 
States  and  which,  if  we  remain  unprepared,  may  seriously 
check  our  progress.  If,  on  the  other  hand,  we  forearm,  we 
may  grasp  the  opportunity  of  taking  our  place  as  the  strong- 
est of  the  world's  bankers  and  furnish  our  industries  with 
the  basis  for  a  solid  expansion. 

(5)  "Does  it  not  appear  ridiculous  that  a  country  owning 
over  two  billions  and  a  half  of  gold  should  not  be  able  to 
mobilize  a  larger  free  gold  reserve  than  two  or  three  hun- 
dred millions  of  dollars,  particularly  when  it  is  apparent  that 
its  future  financial  and  economical  growth  will  depend  upon 
the  extent  of  the  'preparedness*  that  it  can  provide  in  this 
respect?  Our  critics  say  that,  by  concentrating  the  gold  in 
the  Federal  Reserve  banks,  we  shall  make  them  the  target 
for  gold  withdrawals.  But  they  will  be  that  target  anyhow. 
The  only  question  is,  will  they  be  able  to  resist  without 
being  forced  to  take  premature  and  unnecessarily  drastic 
measures  of  defense?  Let  us  suppose  that  our  member 
banks'  excess  cash  reserves  have  been  wiped  out,  either  by 
gold  export  or  by  expansion  of  the  loan  and  deposit  struc- 
ture ;  let  us  suppose  that  our  discount  and  investment  rates 
are  fairly  low  as  compared  with  those  prevailing  in  Europe ; 
let  us  suppose  that  our  shipments  to  foreign  countries  will 
no  longer  exceed  our  imports.  Then,  as  money  flows  where 
it  can  safely  earn  the  highest  returns,  our  bankers  will 
probably  have  to  finance  foreign  countries  both  in  govern- 
ment loans  and  individual  transactions.  Suppose,  then,  that 
Mr.  Ivanoff,  in  Petrograd,  draws  $100,000  at  ninety  days' 
sight  on  an  American  banker  against  a  credit  granted  to  him, 


LOANS    AND    INVESTMENTS        285 

rediscounts  that  paper  in  New  York,  and,  against  this  bal- 
ance, Russia  wants  gold.  Where  will  it  come  from?  The 
member  banks  have  no  more  excess  reserves ;  shall  we  then 
begin  to  withdraw  it  from  circulation  and  how  and  against 
what?  The  New  York  member  bank  will  rediscount  $100,- 
000  of  bankers'  acceptances  or  commercial  paper  with  its 
Federal  Reserve  bank  and  ask  for  gold.  Ultimately,  there- 
fore, the  demand  for  gold  will  be  made  upon  the  Federal 
Reserve  banks.  We  are  faced  with  the  simple  question: 
Will  we  be  strong  enough  to  share  our  plenty,  during  the 
coming  period  of  stress,  with  other  nations  and  be  the 
world's  banker,  or  will  we  be  so  weak  that,  when  these 
demands  come,  we  must  stop  them  at  once  by  raising  our 
discount  rates  high  enough  to  retain  our  gold  at  home? 
Keep  all  the  gold  in  your  vaults  where  it  is  useless  for  your- 
selves and  deprived  of  the  additional  force  that  it  may  gain 
in  the  hands  of  the  Federal  Reserve  banks ;  keep  every  cash- 
till  in  hotels,  railroad  stations,  drygoods  stores  and  what 
not,  filled  with  gold  certificates,  and  you  will  rob  the  country 
of  its  legitimate  opportunity  of  growth,  of  helping  itself,  and 
of  helping  the  world.  Our  foreign  competitors  will  proclaim 
that  only  a  country  willing  to  part  freely  with  its  gold  may 
safely  be  accepted  as  a  world's  banker,  and  they  will  point 
to  the  fact  that,  in  past  critical  periods,  our  banks  stopped 
paying  in  gold.  It  is  our  duty  to  give  to  the  world  an  over- 
whelming evidence  of  our  ability  and  determination  in  the 
future  to  maintain  our  gold  obligations  under  any  and  all 
circumstances. 

(6)  "The  vast  accumulation  of  gold  in  the  hands  of  the 
Federal  Reserve  banks  which  I  am  urging  is  of  great  mo- 
ment in  its  bearing  upon  the  future  of  the  National  bank 
currency.  The  objects  contemplated  in  this  respect  by  the 
Federal  Reserve  Act  are  highly  to  be  commended;  but 
carrying  this  scheme  into  effect  is  subject  to  too  many  de- 
lays. More  comprehensive  action  from  the  beginning  would 


286        LOANS   AND    INVESTMENTS 

have  brought  about  better  results.  The  ultimate  aim  which 
we  must  have  in  mind  is  the  conversion  of  a  large  portion  of 
the  two  per  cent,  government  bonds  now  securing  circula- 
tion into  new  three  per  cent,  bonds,  a  substantial  portion  of 
which  will  gradually  be  absorbed  by  the  people.  This  would 
have  the  consequence  of  reducing  the  amount  of  National 
bank  circulation,  so  that,  at  a  given  point,  whatever  two  per 
cent,  bonds  the  Federal  Reserve  banks  acquired  would  ulti- 
mately be  carried  by  Federal  Reserve  note  circulation,  and 
this,  in  turn,  would  be  of  material  assistance  to  the  Federal 
Reserve  banks  in  earning  their  dividends.  As  the  absorption 
of  the  three  per  cent,  bonds  by  the  public  proceeded,  and  as 
the  growing  acceptance  market  offered  a  wider  field  of  in- 
vestment for  the  Federal  Reserve  banks,  Federal  Reserve 
notes  would  take  the  place  of  Federal  Reserve  bank  notes, 
bankers'  acceptances  and  commercial  paper  would  take  the 
place  of  government  bonds  and  an  elastic  and  live  currency 
would  replace  the  present  inelastic  government  bond  se- 
cured currency.  In  order  to  carry  out  this  process,  however, 
it  will  be  necessary  normally  to  maintain  against  Federal 
Reserve  notes  at  least  the  forty  per  cent,  reserve  required 
by  law,  as  against  the  five  per  cent,  of  reserves  now  required 
against  National  bank  notes.  And  this,  again,  is  an  added 
reason  for  facilitating  the  concentration  of  gold  in  the  Fed- 
eral Reserve  banks,  so  that  they  may  be  strong  enough  to 
sustain  this  large  volume  of  circulation  on  the  higher  reserve 
basis.  The  larger  powers  which  we  should  enjoy  would  not, 
therefore,  be  employed  to  inflate  circulation.  On  the  con- 
trary, as  a  net  result,  it  would  be  used  for  the  purpose  of 
building  up  a  circulation  covered  by  a  far  stronger  gold 
reserve  than  that  of  the  National  bank  notes.  Until  the 
volume  of  the  latter  has  been  materially  reduced,  and  until 
Federal  Reserve  notes  may  be  accepted  as  reserve  money  by 
the  member  banks,  the  lending  power  of  the  Federal  Reserve 
banks  will  remain  hampered. 


LOANS   AND    INVESTMENTS        287 

(7)  "The  Federal  Reserve  banks  have  made  investments 
aggregating  at  present  about  $180,000,000  and  have  out- 
standing a  net  circulation  of  about  $16,000,000.  That  means 
that  for  $164,000,000  of  investments  they  have  paid  gold  and 
thereby  have  reduced  their  reserve  power  to  that  extent.  If 
they  could  have  paid  in  Federal  Reserve  notes  instead  of 
gold,  as  they  should  have  been  permitted  to  do,  they  would 
have  wasted  only  forty  per  cent,  of  this  amount  and  would 
have  retained  the  balance,  that  is,  about  one  hundred  mil- 
lions, as  a  potential  reserve  for  additional  note  issue.  As 
stated  before,  it  does  not  necessarily  follow  that  Federal 
Reserve  banks  would  have  made  larger  investments  at  this 
time;  it  is  not  at  all  likely  that  they  would  have  done  so. 
But  emphasis  must  be  laid  upon  the  resulting  reductions  of 
their  power  to  assist  the  country  in  an  emergency.  The 
argument  is  used  that  if  Federal  Reserve  notes  had  been 
paid  out  and  could  have  been  counted  as  reserve  money  by 
the  stock  banks,  these  notes  would  have  gone  into  the  vaults 
of  the  member  banks  as  reserve  money  and  caused  a  further 
expansion  of  loans.  But  we  must  not  forget  that  the  same 
result  has  followed  by  the  Federal  Reserve  banks  paying  out 
gold.  As  far  as  the  member  banks  are  concerned,  the  effect 
is  the  same  whether  they  receive  $164,000,000  in  gold  or  in 
Federal  Reserve  notes  which  may  be  counted  as  gold.  But 
the  difference  is,  as  we  have  stated,  that  under  the  present 
system  the  lending  power  of  the  Federal  Reserve  System  is 
being  impaired  too  fast.  Federal  Reserve  notes  'shall  be 
obligations  of  the  United  States  and  shall  be  receivable  by 
all  National  and  member  banks  and  the  Federal  Reserve 
banks  and  for  all  taxes,  customs  and  public  dues.  They  shall 
be  redeemed  in  gold  at  the  Treasury/  etc.  Did  we  not  stop 
half-way  when  we  provided  that  banks  are  thus  to  receive 
Federal  Reserve  notes  in  payment  of  debts  among  each 
other,  and  from  their  depositors,  but  cannot  count  them  as 
reserve  for  the  purpose  of  discharging  their  deposit  liabil- 


288        LOANS   AND   INVESTMENTS 

ities  ?  As  a  consequence,  banks  when  settling  with  each  other 
through  clearing  do  not  accept  Federal  Reserve  notes,  but 
must  settle  with  lawful  reserve  money — that  is,  substantially 
in  gold.  If,  however,  a  bank  settled  directly  with  another 
bank  it  could  pay  in  Federal  Reserve  notes  and  the  payee 
bank  could  then  send  the  Federal  Reserve  notes  to  its  Fed- 
eral Reserve  bank,  create  a  balance  and  then  count  that  as 
reserve.  It  is  fortunate  that  the  new  amendment  will  permit 
member  banks  to  carry  any  part  of  their  required  vault 
reserve  as  a  balance  with  the  Federal  Reserve  bank  and  to 
count  it  as  reserve.  It  is  hoped  that  this  will  cause  member 
banks  promptly  to  adopt  the  habit  of  settling  their  balances 
with  each  other  by  transfer  of  credit,  through  their  Federal 
Reserve  banks,  thereby  releasing  gold  needlessly  tied  up  in 
clearing  operations  and  in  their  vaults  and  remedying,  to  a 
certain  extent  at  least,  these  anomalous  conditions. 

(8)  "In  dealing  with  this  question  of  reserves  and  note 
issue,  it  is  proper  and  necessary  that  we  proceed  step  by 
step.  Splendid  progress  has  been  made  in  these  last  two 
years  and  we  realize,  of  course,  that  the  tracks  must  be 
shifted  many  a  time  before  we  can  reach  our  final  goal.  But 
we  must  be  clear  about  this  ultimate  aim  and  we  must  recog- 
nize the  absolute  necessity  of  taking  certain  consecutive 
steps  before  monetary  and  banking  reform  will  be  complete. 
Ultimately  we  must  rid  our  country  of  the  confusing  multi- 
plicity of  currency  with  which  we  are  now  afflicted,  and  the 
Treasury  will  have  to  stop  issuing  small  denomination  gold 
certificates.  The  circulating  currency  of  the  country  ought 
to  be  silver  certificates  in  the  small  denominations,  and 
Federal  Reserve  notes.  The  best  place  for  gold  and  gold 
certificates  will  be  in  the  Federal  Reserve  banks.  The 
National  bank  currency  ought  to  be  systematically  with- 
drawn, and  the  greenbacks  ought  to  be  gradually  turned 
into  gold  certificates  as  the  missing  gold  cover  from  time  to 
time  is  produced  by  the  excess  profits  to  be  received  from 


LOANS   AND    INVESTMENTS        289 

the  Federal  Reserve  banks  or  by  some  more  rapid  process 
that  the  future  may  evolve.  While  this  process  is  taking  its 
course  I  think  we  are  fully  justified  in  permitting  the  Fed- 
eral Reserve  banks  to  count  greenbacks  as  part  of  their 
metallic  reserve.  It  is  freely  admitted  that  this  is  not  abso- 
lutely good  banking  theory.  But  with  the  $153,000,000  gold 
behind  these  notes  and  the  power  given  to  the  United  States 
to  provide  the  additional  gold  cover  by  a  sale  of  govern- 
ment bonds,  we  may  be  warranted  in  temporizing  and  not 
making  an  over-rigid  discrimination. 

(9)  "One  cannot  deal  with  the  future  of  our  Federal 
Reserve  System  and  our  reserve  problem  without  being 
puzzled  by  the  question,  what  will  be  the  coming  standard 
of  differentiation  between  central  reserve  cities,  reserve 
cities  and  country  bank  places  when,  after  November  16, 
1917,  balances  with  correspondent  banks  will  no  longer 
count  as  reserve.  I  cannot  undertake  to  discuss  that  prob- 
lem today,  but  I  think  it  is  timely  to  point  to  this  phase  and 
invite  you  to  give  it  your  most  careful  consideration.  The 
time  is  not  distant  when  we  shall  have  to  deal  with  this 
conundrum  and  we  shall  welcome — indeed,  we  shall  need — 
your  very  best  thoughts  in  the  matter.  The  Federal  Reserve 
System  is  the  beginning  of  an  imposing  structure  to  be 
erected  upon  a  broad  foundation.  It  will  prove  a  costly  edi- 
fice unless  it  is  developed  to  its  full  growth  along  these 
broad  lines.  Member  banks  and  the  country  at  large  have  a 
very  vital  and  obvious  interest  in  this,  and  they  may  well 
insist  that  there  be  no  stopping  half-way  or  haphazard  addi- 
tions or  little  patchwork  here  and  there.  The  banks  and 
country  are  now  entitled  to  enjoy,  and  will  soon  require, 
the  strongest  possible  system,  and  the  further  it  progresses, 
the  more  the  concentration  of  gold  in  the  Federal  Reserve 
banks  proceeds,  the  further  the  discount  market  develops 
and  the  further  grows  the  habit  of  banks,  large  and  small, 
to  invest  in  bankers'  and  trade  acceptances,  the  less  will  it 


290        LOANS    AND    INVESTMENTS 

be  necessary  for  them  to  keep  unduly  large  sums  locked  up 
in  their  vaults  and  the  easier  will  it  be  for  Federal  Reserve 
banks  to  return  a  portion  of  their  paid-in  capital.  The  roads 
to  reduced  reserve  and  capital  requirements  lie  in  these  di- 
rections. If  member  banks  are  to  rely  for  their  protection 
primarily  upon  their  ability  to  create  balances  with  their 
Federal  Reserve  banks  they  must  be  certain  that  they  have 
in  their  possession  an  easy  means  of  approach,  a  reliable 
key  that  will  open  for  them  the  floor  leading  to  the  Federal 
Reserve  banks*  vaults." 


EXERCISES 

Questions  to  be  Answered  by  Students 

(Chapter  I — Commercial  Loans) 

1.  Define  "liquid  assets"  and  explain  why  the 
assets  of  a  commercial  bank  should  be  liquid. 

2.  What  are  "lines  of  credit"  and  why  is  it 
difficult  to  curtail  lines  of  credit  in  times  of  financial 
stringency? 

3.  Discuss  ways  and  means  by  which  a  com- 
mercial bank  may  replenish  its  reserves. 

4.  Describe  the  ultimate  effect  of  the  general 
contraction  of  loans. 

5.  How  does  the  Federal  Reserve  System  bene- 
fit commercial  banks  in  maintenance  of  liquid  assets 
and  adjustment  of  reserves. 

6.  Define  "current  assets"  and  give  one  or  more 
examples. 

7.  Define  and  exemplify  "current  liabilities." 

8.  What  information  should  bank  credit  depart- 
ments have,  and  how  may  such  information  be  best 
obtained? 

9.  In  extending  credit,  what  circumstances  and 
conditions  should  be  considered  beyond  ordinary 
statements  of  assets  and  liabilities? 

10.  Discuss  the  ratio  of  collections  to  maturities. 

11.  What  are  the  advantages  of  "trade  accep- 
tances" as  compared  with  single  name  commercial 
paper? 

291 


292        LOANS    AND    INVESTMENTS 

12.  What  are  the  advantages  of  "single  name 
commercial  paper"  as  compared  with  trade  accep- 
tances? 

13.  Define  "bank  acceptances"  and  explain  their 
utility. 

14.  In  your  judgment  what  portion  of  a  com- 
mercial bank's  available  funds  should  be  invested 
in  (1)  marketable  securities,  (2)  commercial  paper 
purchased  in  the  open  market,  (3)  loans  to  cus- 
tomers? 

(Chapter  II — Agricultural  Loans) 

15.  Define   "commodity  paper"   and  give  ex- 
amples of  instruments  thus  termed. 

16.  In  what  way   does   the   Federal   Reserve 
System  favor  agricultural  loans? 

17.  Name  the  principal  grain  growing  States. 

18.  Explain  (1)  prevailing  methods  of  market- 
ing grain,  (2)  process  of  distributing  it,  (3)  manner 
of  storage. 

19.  Describe  the  security  generally  required  by 
banks  in  making  grain  loans. 

20.  Do  banks  generally  give  grain  dealers  open 
lines  of  credit,  and  if  so,  why? 

21.  Name  the  cotton  growing  States,  and  state 
the  amount  of  cotton  produced  in  the  United  States. 

22.  Describe  the  manner  in  which  banks  make 
loans  to  cotton  planters. 

23.  How  do  banks  make  advances  to  cotton 
buyers,  and  on  what  security? 


LOANS    AND    INVESTMENTS        293 

24.  Define  "cotton  futures"  and  discuss  trans- 
actions in  connection  with  them. 

25.  Discuss  the  advantages  and  disadvantages 
of  "cattle  loans." 

26.  Define  "cattle  loan  companies"  and  explain 
their  operations. 

27.  What  kind  of  business  statements  should 
be  required  from  farmers? 

28.  In  making  loans  to  farmers,  what  are  the 
principal  circumstances  to  be  considered? 

(Chapter  III— Stocks  and  Bonds) 

29.  What  is  the  fundamental  difference  between 
"stocks"  and  "bonds?" 

30.  Distinguish  between  "common"  and  "pre- 
ferred" stocks. 

31.  What  may  be  said  in  favor  of  the  issuance 
of  shares  of  stock  without  par  value? 

32.  Describe  the  requirements  in   connection 
with  the  transfer  of  stocks. 

33.  Specify  some  of  the  conditions  that  deter- 
mine the  titles  under  which  bonds  are  classified. 

34.  Define  "coupon  bonds,"  "registered  bonds,", 
and  "registered  coupon  bonds." 

35.  What  particular  facts  and  circumstances 
should  be  considered  in  buying  municipal  bonds? 

36.  What  is  the  usual  procedure  in  the  issuance 
and  marketing  of  bonds? 

37.  Define  in  your  own  language  the  financial 
terms  "bull"  and  "bear." 


294        LOANS   AND    INVESTMENTS 

38.  Explain  the  meaning  of  the  terms  "short" 
and  "long"  as  applied  to  stock  market  transactions. 

39.  Describe  "watered  stock"  and  specify  two 
issues  that  in  your  judgment  may  be  so  classified. 

40.  Discuss  stocks  and  bonds  as  investments. 

41.  Specify  bonds  suitable  for  investment  by  a 
commercial  bank. 

42.  What  classes  of  bonds  are  suitable  for  sav- 
ings banks  or  trust  funds? 

(Chapter  IV— Collateral  Loans) 

43.  Distinguish  between  "pledge,"  "lien"  and 
"chattel  mortgage,"  and  show  which  gives  the 
greatest  rights. 

44.  May  a  National  bank  hold  in  pledge  as  col- 
lateral security  for  a  loan  made,  or  to  be  made, 
shares  in  the  stock  of  another  National  bank? 

45.  Can  a  National  bank  make  a  valid  loan  on 
the  security  of  its  own  stock? 

46.  What  are  the  essentials  of  a  valid  delivery? 

47.  What  is  "constructive  delivery"  and  is  it 
sufficient  to  constitute  a  pledge? 

48.  Explain  the  manner  in  which  a  broker  may 
hypothecate  his  customers'  securities. 

49.  When  goods  in  a  warehouse  on  which  a 
warehouse  receipt  has  been  issued  are  attached  by 
order  of  a  court,  what  are  the  rights  of  a  bank  hold- 
ing the  receipt  as  collateral? 

50.  In  what  respect  does  a  warehouse  receipt 
differ  from  a  bill  of  exchange  as  to  negotiability? 


LOANS   AND   INVESTMENTS        295 

51.  Distinguish  between  warranties  and  liens. 

52.  Of  what  importance  is  a  bill  of  lading  at- 
tached to  a  draft  in  payment  of  goods  for  export? 

53.  How  does  a  bill  of  lading  differ  from  an 
ordinary  receipt? 

54.  If  a  bill  of  lading  held  by  a  bank  as  col- 
lateral for  a  loan  turns  out  to  have  been  forged  by 
one  of  the  carrier's  representatives,  who  is  re- 
sponsible, and  why? 

55.  What  is  the  difference  between  a  "Straight" 
bill  of  lading  and  an  "Order"  bill  of  lading? 

56.  Explain  why  a  bank  should  not  surrender 
a  bill  of  lading  attached  to  a  draft  without  accep- 
tance or  payment  of  the  draft. 

(Chapter  V — Seasonal  Demands  for  Money) 

57.  Describe   seasonal   variations   in   demands 
for  money  in  New  York  City. 

58.  What  are  the  seasonal  variations  in  demands 
for  money  in  your  own  locality? 

59.  Explain  how  seasonal  variations  in  demands 
for  money  influence  prices  of  bonds. 

60.  How  do  seasonal  demands  for  money  affect 
bank  reserves? 

61.  Define   "secondary  reserves"   and  explain 
their  utility. 

62.  What  are  the  three  essential  characteristics 
of  secondary  reserves? 

63.  What   is   meant   by   "emergency   market- 
ability?" 


296        LOANS   AND   INVESTMENTS 

64.  Discuss  the  relative  merits  of  bonds  and 
commercial  paper  as  secondary  reserves. 

65.  Specify  a  few  issues  of  bonds  that  would  in 
your  judgment  be  suitable  for  secondary  reserves. 

66.  How  does  commercial  paper  serve  the  pur- 
pose of  secondary  reserve  in  Europe? 

67.  Why  has  commercial  paper  in  the  United 
States  been  largely  local  in  character? 

68.  How  may  a  commercial  paper  market  be 
developed  in  the  United  States? 

69.  In  what  manner  will  the  Federal  Reserve 
System  tend  to  change  the  character  of  secondary 
reserves? 

70.  Define  "business  cycles"  and  discuss  their 
cause  and  effect. 

(Chapter  VI — International  Exchange) 

71.  Define  "foreign  exchange"  and  explain  the 
difference  between  foreign  and  domestic  exchange. 

72.  What  is  the  "mint  par  of  exchange"  and  how 
is  it  computed? 

73.  What  is  the  "gold  import  point"  and  under 
what  circumstances  is  gold  imported  from  foreign 
countries  to  the  United  States? 

74.  What  is  the  "gold  export  point"  and  under 
what  circumstances   is   gold  exported   from  the 
United  States  to  foreign  countries? 

75.  What  factors  determine  the  price  of  gold  in 
international  exchange? 

76.  What  are  "cable  transfers"  and  why  is  the 


LOANS   AND    INVESTMENTS        297 

cable  transfer  rate  of  exchange  higher  than  the  de- 
mand rate  of  exchange? 

77.  Name  and  describe  the  different  kinds  of 
time  bills  of  exchange. 

78.  Define  "arbitrage"  and  illustrate  an  arbi- 
trage transaction. 

79.  What  are  "finance  bills"  and  how  are  they 
handled? 

80.  Describe   the   three   forms    of    "revolving 
credit." 

81.  Describe  the  methods  of  financing  imports 
and  exports. 

82.  How  is  the  demand  rate  of  exchange  deter- 
mined? 

83.  Explain  the  relation  of  interest  rates  to  for- 
eign exchange  rates. 

84.  Define  "dollar  exchange"  and  discuss  its  de- 
velopment. 

(Chapter  VII — Bonds  and  Circulating  Notes) 

85.  Explain  the  difference  between  the  liability 
of  a  bank  in  issuing  bank  notes  and  the  liability  of 
a  bank  receiving  deposits. 

86.  Why  do  bank  notes  remain  outstanding 
longer  than  bank  checks? 

87.  What  are  the  principal  methods  of  protect- 
ing bank  notes? 

88.  Explain  the  Canadian  "guaranty  fund"  for 
the  protection  of  bank  notes  and  describe  its  oper- 
ation. 


298        LOANS   AND   INVESTMENTS 

89.  How  has  bond-secured  currency  under  the 
National  Bank  Act  proved  unsatisfactory? 

90.  Specify  the  different  forms  of  currency  in 
the  United  States. 

91.  What  are  "greenbacks"  and  how  are  they 
secured. 

92.  Define  "inelasticity  of  currency"  and  explain 
its  effects. 

93.  Discuss  the  difference  between  protection 
accorded  to  bank  notes  and  to  bank  deposits. 

94.  What  forms  of  notes  are  issued  under  the 
Federal  Reserve  Act? 

95.  Explain  "Federal  Reserve  Notes." 

96.  What  are  "Federal  Reserve  Bank  Notes" 
and  under  what  conditions  are  they  issued? 

97.  Explain  the  provisions  of  the  Federal  Re- 
serve Act  for  the  conversion  of  two  per  cent,  bonds. 

98.  Discuss  the  relationship  between   Federal 
Reserve  notes  and  bank  reserves. 

99.  Explain  the  procedure  of  Federal  Reserve 
banks  in  taking  over  the  bonds  held  by  National 
banks  as  security  for  circulation. 

100.  Why  should  gold  be  concentrated  in  the 
Federal  Reserve  Banks? 

INSTRUCTIONS.— In  City  Chapter  Classes  the 
foregoing  questions  are  to  be  used  in  connection 
with  the  respective  subjects  to  which  they  pertain. 
Correspondence  Chapter  students  will  submit  an- 
swers to  all  of  the  one  hundred  prescribed  questions 
at  the  same  time. 


INDEX 

Numbered  Paragraphs 

Adequacy  of  Reserves 169 

Adjustment  of  Reserves 13 

Advantages  of  Single  Name  Paper   39 

Advantages  of  Trade  Acceptances  38 

Agricultural  Paper  for  Rediscount 82 

Aldrich-Vreeland  Act  17 

Altered  Bills  150 

Arbitrage  198 

Arrival  Rates   212 

Assets  Must  Be  Liquid  5 

Assistance  of  Federal  Reserve  Banks 62 

Attachment  of  Goods  Under  Bills  of  Lading. .  153 

Bank  Acceptances  41 

Bank  Advances  to  Cotton  Buyers 59 

Bank  Balances  and  Bonds 10 

Bank  Notes  and  Checks 224 

Bank  Notes  and  Deposits 222 

Banks  and  Stock  Exchanges   119 

Bills  of  Lading "  146 

Bond  Issuance   Ill 

Bond  Selling  Syndicates    114 

Bond  Underwriting  Syndicates 113 

Bonds  and  Bank  Notes  229 

Bonds  and  Their  Classification   97 

Bonds  as  Investments   120 

Bonds  as  Secondary  Reserves   180 

299 


300        LOANS   AND   INVESTMENTS 

Borrowing  and  Lending  Exchange  Markets. .  211 

Business  Cycles 182 

Buying  Cattle  Loans 79 

Cable  Transfers  194 

Cash  and  Credit 4 

Certificates  of  Stock 91 

Classes  of  Notes 234 

Classification  of  Time  Bills 196 

Collateral  Loan  Agreements 159 

Collateral  Notes 158 

Commercial  Paper  in  Europe 175 

Commodity  Paper 42 

Common  Carriers 145 

Cotton  and  Its  Production 52 

Cotton  Exchanges 66 

Cotton  Merchants  and  Exporters '. .  63 

Credit  Analysis  and  Single  Name  Paper 34 

Currency  and  Bank  Reserves 246 

Current  Assets  24 

Current  Liabilities  25 

Danger  from  Borrowing  in  Both  Ways 40 

Demand  for  Notes 236 

Demand  Rates  of  Exchange 185 

Development  of  Dollar  Exchange 219 

Documentary  Acceptance  Bills 197 

Domestic  Exchange 184 

Drainage  and  Reclamation  Bonds 109 

Equipment  Bonds   107 

European  Financing  of  Am.  Foreign  Trade  . .  202 

European  War  and  the  Exchanges   214 


LOANS   AND   INVESTMENTS  301 

Export  and  Import  Points 191 

False  Bills  148 

Farmers'  Statements 80 

Federal  Reserve  Act 18 

Federal  Reserve  Bank  Notes 238 

Federal  Reserve  Notes  and  Bank  Reserves. .  242 

Finance  Bills . .  199 

Financial  Terms 118 

Financing  Exports  of  Cotton 65 

Financing  of  Exports 204 

Financing  of  Imports 203 

Foreign  Exchange 183 

Foreign  Exchange  Departments   205 

French  Exchange 188 

General  Contraction  of  Loans 14 

General  Loan  Contraction  to  Be  Avoided. . .  16 

German  Exchange 189 

Goods  Lost  or  Damaged  in  Transit 152 

Goods  Not  Owned  by  Shipper 151 

Grain  Crops 43 

Grain  Elevators  and  Warehouses 44 

Grain  Exchanges 47 

Grain  Loans   48 

How  Demand  Rate  of  Exchange  is  Determined  206 

Industrial  Bonds   106 

Inelasticity  of  Currency   231 

International  Borrowing 207 

Lack  of  Commercial  Paper  Market 179 

Land  Mortgage  Bonds 110 

Legal  Tender  and  Other  Reserve  Credits 170 


302        LOANS   AND    INVESTMENTS 

Limited  Significance  of  Balance  Sheets ,  32 

Lines  of  Credit 6 

Liquidation  of  Assets 29 

Liquidness  of  Loans  to  Depositors 7 

Live  Stock  Loans 69 

Loans  and  Deposits   3 

Loans  by  Foreign  Banks 208 

Loans  on  Cotton  in  Warehouses 61 

Managers'  Shares 94 

Marketing  Cotton   57 

Marketing  Grain 45 

Mint  Par  of  Exchange 186 

Municipal  Bonds   103 

National  Foreign  Trade  Policy 221 

Negotiable  Warehouse  Receipts  138 

Negotiation  of  Order  Bills  147 

Non-Liability  of  Pledgee  as  Warrantor 154 

Non-Negotiable  Warehouse  Receipts 137 

Notes  as  Needed  237 

Notes  Based  Upon  Business  Transactions . . .  243 

Notes  Under  the  Federal  Reserve  Act 233 

Panic  Demands  for  Currency 240 

Policy  of  Note  Issue 241 

Position  of  London 213 

Problems  of  Conversion  (of  Government 

Bonds)    245 

Procedure  in  Issuing  Bonds 112 

Process  of  Conversion  235 

Protection  of  Notes  225 

Public  Utility  Bonds   105 


LOANS   AND   INVESTMENTS        303 

Quarantine  Line 73 

Railroad  Bonds 104 

Rates  on  Time  Bills 195 

Ratio  of  Collections  to  Maturities  33 

Ratio  of  Current  Assets  to  Liabilities 28 

Rediscounts  9 

Relation  of  Interest  Rates  to  Exchange  Rates  209 

Relation  of  Notes  to  Currency 223 

Reserve  Banks  and  Commercial  Loans 20 

Reserve  Banks  and  Liquidness 19 

Revolving  Credit  200 

Rights  and  Liabilities  of  Pledger 128 

Sales  Made  by  Grain  Buyers 49 

Seasonal  Movements  in  Money  Markets 160 

Seasonal  Strains  on  Bank  Reserves  168 

Seasonal  Variations  in  Foreign  Exchange  . .  166 

Seasonal  Variations  in  Prices  of  Bonds 167 

Secondary  Reserves  and  Their  Character  . .  171 
Secondary  Reserves  Under  Federal  Reserve 

System 181 

Security  for  Bank  Notes 228 

Shares  Without  Par  Value 93 

Shipper's  Loan  and  Count  155 

Significance  of  Changes  in  Exchange 

Quotations 190 

Situation  in  the  United  States 178 

Sources  of  Payment  of  Bank  Loans 21 

Spent  Bills 149 

Statements  of  Borrowers 27 

Status  of  American  Note  Currency 230 


304        LOANS   AND   INVESTMENTS 

Sterling  Exchange 187 

Stock  Exchanges 115 

Stocks  and  Their  Classification 86 

Surrender  of  Bills  of  Lading  to  Drawees 157 

Taking  Over  Government  Bonds 244 

Theory  of  Note  Issue 227 

The  War  and  the  London  Acceptance 215 

The  War  and  the  London  Discount   Market  216 

The  War  and  the  London  Sight  Rate  218 

The  War  and  the  New  York  Exchange 

Market 217 

Timber  Bonds 108 

Time  Factor  in  Gold  Shipments 193 

Time  of  Retirement  (of  Government  Bonds) .  239 

Trade  and  Single  Name  Paper  Compared  ...  36 

Trade  Paper  35 

Transfer  of  Stocks 95 

Travelers'  Letters  of  Credit 201 

Ultimate  Effects  of  Contraction 15 

United  States  Cotton  Futures  Act 68 

Utility  of  Bankers'  Time  Bills 210 

Variable  Prices  of  Gold ' 192 

Volume  of  Sales 31 

Voting  Trust  Certificates 92 

Warehousemen  and  Warehouse  Receipts 135 

Warehousemen's  Liens 143 

Warranties  of  Genuineness 141 

What  May  be  Pledged 125 

Why  Notes  Are  Issued  226 

Word  "Notify"  on  Order  Bills 156 


